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R e g u l a t o r y C o s tAnalys is:A n O v e r v i e wD a v i
d A . G a r v i n a n d R o b e r t A . L e o n eD a v i d G a r v
i n a n d R o b e r t L e o n e a r e b o t h o n t h e ] a c u i t
y o f t h eG r a d u a t e S c h o o l o f B u s in e s s A d m i n
i s t r a t i o n a t H a r v a r dU n i v e r s it y . T h e a t t
th o r s w o u l d l i ke to t h a n k t h e N a t i o n a lC o m m
i s s i o n o n A i r Q u a l i t y f o r ] i n a nc i a l s u p p
o r t , a n d J o h nM e y e r , M i k e O ' H a r e , a n d m e m
b e r s o f th e C os t M e t h o d o l o g yP a n e l o f t h e N
a t i o n a l C o m m i s s i o n o n A i r Q u a l i t y f o r h e
l p f u lc o m m e n t s o n a t , e a r li e r d r a] t o f t h i
s a r ti c le . T h e v i e w s e x p r e s s e dh e r e , h o w e
v e r , a r e th o s e o f t h e a u t h o r s a l o n e , a n d d
o n o t, n e ce s s a ri l y r ef l ec t t h o s e o f t h e c o m
m i s s i o n .
C a r e f u l a s s e m b l y a n d s o p h i s t i c a t e d an
a l y s is o f c o s t i n f o r m a t i o n i sv i ta l ly i m p o
r t a n t t o e ff ec ti v e e n v i r o n m e n t a l c o n t r o
l r e g u l a t i o n . I n t h isa r t ic l e , w e i d e n t i f
y t h e p o s s i b l e u s e s o f s u c h c o s t i n f o r m a t
i o n , c a t a l o gt h e a p p r o p r i a t e m e t h o d o l o
g i e s to o b t a i n i t, a n d e v a l u a te t h e s t r e n g
t h sa n d w e a kn e ss e s o f c o m m o n c o s t e s t i m a t
i o n t e c h n i q u e s . T h r o u g h o u t ,o u r e m p h a s
i s i s o n p r o v i d i n g g u i d a n c e f oi- a n a ly s ts c
o n t e m p l a t i n gf u r t h e r a p p l i e d w o r k i n t i
le a r ea .T H E I M P O R T A N C E O F G O A L SI t is e s se n t
ia l t o r e co g n i z e th a t n o s i n g l e c o st m e a s u r
e - - a n d b yi m p l i c a t i o n , n o s i n gl e t e c h n i q
u e f o r c o m p u t i n g t he co s t s o f r e g u l a to r yc o
m p l i a n c e - - p r o v id e s a l l t h e i n f o r m a t i o
n p o l ic y m a k e r s de si re . C o sts t u d i e s , a f t e r
a l l , a r e i n p u t s t o t h e p o l i c y p r o c e s s a n d
a r e g e n e r a l l yf r a m e d w i t h p a r t i c u la r q u e
s t i o n s in m i n d . S o m e s t u di es , f o r e x a m p l e
,f o c u s o n t i l e t o t a l r e s o u r c e c o s t s t o s o
c i e t y o f c o m p l i a n c e w i t h a i re m i s s i o n s s
t a n d a r d s , o t h e r s e m p h a s i z e m o r e s u b t l e
a n d d i f f i c u l t t od i s c e rn i n t r a i n d u s t r y ,
i n t e r i n d u s t r y , o r i n t e r n a t i o n a l c o m p e
t i t i v ei m p a c t s o f r e g u l a t i o n , w h i l e s ti
ll o t h e r s s ee k t o c o m p a r e c o m p l i a n c ec o st s
u n d e r a l t e r n a t iv e r e g u l a t o r y r e g i m e s .
N o s i n g l e a p p r o a c h t o c o s te s t i m a t i o n c a
n d e a l s i m u l t a n e o u s l y w i t h a l l t h es e i ss u
es . D i f fe r e n tb o d i e s o f d a t a , d i f f e r e n t m
e t h o d o l o g i e s , a n d d i f fe r e n t a n a l y t i c a
lEnvironmental Impact Assessment Review, V. 2, N. I. . . .
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f r a m e w o r k s a re r e q u i re d . T h u s , p o l i c y
m a k e r s , w o r k i n g t o g e t h e r w i t hc o s t an a l y
s ts , m u s t f ir s t d e c i de u p o n t h e g o a l s o f i n
d i v i d u a l c o s t s t u d i e sb e f o r e f o r m a l a n a
l y s i s c a n b e g i n .Co s ts , I m p a c t s , a n d A l tern
a t iv e Reg u l a to ry R eg i m esW h i l e t h e s p e c i f ic
g o a l s o f r e g u l a t o r y c o s t a n a l y s i s a r e p o
l i c y d e c i s i o n s ,t h e r e a r e a n u m b e r o f b a s
ic c o n c e p t s t h a t c a n h e l p t o c l a r if y t h e c h
o i c e sa m o n g g o a l s . C o n s i d e r f i rs t t il e d i
f f e r e n c e b e t w e e n t h e co s t s a n di m p a c t s o f
r e g u l a t i o n s , a d i s t i n c t i o n t h a t c lo s e ly
p a r a ll e l s t h ee c o n o m i s t s ' s e p a r a t i o n o f
e f f i c ie n c y a n d e q u i t y . C o s t s r e f er t o t h
ep r o d u c t i v e r e so u r c es t h a t a r e r e q u i r e d
t o i n s u r e c o m p l i a n c e w i t he n v i r o n m e n t a
l r e g u l a t i o n s - - r e s o u r c e s w h i c h i n t h e a
b s e nc e o fr e g u l a t i o n c o u l d b e e m p l o y e d i n
a v a ri e ty o f a l t e rn a t i v e u s es . M e a s u r e dc o
r re c tl y , t h e s e co s ts r e p r e s e n t o p p o r t u n i
t i e s s o c ie t y m u s t f o r g o t oa c h i e v e i t s e n v
i r o n m e n t a l g o a l s . I m p a c t s , i n c o n t r a s t
, r e f e r t o t h ed i f f e r e n t i a l i n c i d e n c e o f
t h e s e c o s t s o n v a r i o u s g r o u p s i n s o c i e ty
, a n d a ss u c h , d e al e x p l i c i t ly w i t h i ss u e s
of d i s t r i b u t i o n a n d e q u i t y . A i r q u a l i t ys
t a n d a r d s , f o r e x a m p l e , m a y i m p o s e d i f f e
r e n t c o m p l i a n c e c os t s p e ru n i t o f o u t p u t o
n l a rg e a n d s m a l l f ir m s , j u s t as t h ey m a y b e n
e f i t s o m eg e o g r a p h i c a l r e g i o n s a t t il e e x
p e n s e o f o t h e r s . S t r i c tl y s p e a k i n g , t h e
s ei m p a c t s a r e n o t c o s ts i n a n e c o n o m i c s en
s e, f o r th e y d o n o t r e p r e s e n to p p o r t u n i t i
e s s o c ie ty m u s t f o r g o , b u t r a t h e r i n v o l v e
th e r e d i s t r i b u t i o no f o p p o r t u n i t i e s a m o
n g v a r i o u s g r o u p s i n s oc ie ty . I n t h e p o li t i
c a ls p h e r e , t h e se d i s t r i b u t i o n a l i ss u e s
a r e o f t e n - a c c o r d e d t h e h i g h e s tp r i o r i t
y , a n d p l a y a n i m p o r t a n t r o l e i n t h e s h a p i
n g o f p o l ic y .B o t h c o st s a n d i m p a c t s a r e l i
k e l y t o va r y u n d e r a l t e r n a t iv er e g u l a t o r
y r e g i m e s b e c a u s e t h e e ff i ci e n cy a n d e q u i
t y i m p l i c a t i o n s o f ag i v e n l ev el o f e n v i r o
n m e n t a l q u a l i t y a re n o t in v a r i a n t t o t h e m
e t h o d o fr e g u l a t o r y c o n t r o l . D i f fe r e n t
st ra t eg i es p e r m i t f i r m s t o r e s p o n d i nd i f fe
r e n t w a ys , o f t en c h a n g i n g t h e c os ts o f c o m p
l i a n c e . A t p r es e n t , aw i d e r a n g e o f a l t e rn
a t i v e a i r p o l l u t i o n c o n t r o l s t ra t eg i e s a
r e b e i n gc o n t e m p l a t e d , t es te d , o r e m p l o y
e d ; a m o n g t h o s e m o s t o f t e n d i s c u s se da re s
y s t e m s b as e d o n a m b i e n t s t a n d a r d s , o n e f
f l u e n t f ee s, o n m a r k e t a b l ep e r m i t s , a n d o
n t h e s o- c al le d " b u b b l e c o n c e p t . 'u E v e n if
a c o m p a r i s o no f t w o o f t h e s e a l t e r n a t i v e
c o n t r o l s t r a t e g ie s r e v e a l e d s i m i l a r l e
v e ls o ft o ta l r e s o u rc e c os ts , p o l i c y m a k e r s
w o u l d n o t b e in d i f f e r e n t t o w a r d t h et w o o p
t i o n s b e ca u s e it w o u l d b e h i g h l y u n l i k e l y
t h a t s u c h ac o m p a r i s o n w o u l d a l s o s h o w s i
m i l a r d i s t r i b u t io n a l i m p a c t s . A s ar e su l
t, i t is i m p o r t a n t t o p a y e q u a l a t t e n t i o n t
6 b o t h c o s t a n d i m p a c tq u e s t i o n s i f c o s t s
t u d i e s a r e t o b e u s e f u l t o p o l i c y m a k e r s
.W h i l e t h e r el a t iv e m e r i t s o f a l t e r n a t i v
e p o l i c i e s c a n b e e n d l e s s l yd e b a t ed , t h e i
m p o r t a n t p o i n t i s t h a t m o s t c o s t s t u d i es
h a v e t a k e n t h er e g u l a t o r y e n v i r o n m e n t a
s g i v e n . W h i l e t h e se s t u d i es o f t e n p r o v i d
ev a l u a b l e i n f o r m a t i o n o n t h e c o s ts a n d i m
p a c t s o f d i f f e re n t s t a n d a r d su n d e r t h e p r
e v a i l i n g r e g u l a t o r y s c h e m e , t h e y s e l d o
m p r o v i d e t h e ba s isf o r a c o m p a r a t i v e a n a l
y s is o f r e g u l a t o r y r e g i m e s . A n a n a l y s i s
o f th a ts o r t r e q u i r e s a v e r y d i f f e r e n t a p p
r o a c h , a n d n e c e s s i ta t e s d i f f e r e n t d a t a
.T o e v a l u a te a s y s t e m o f m a r k e t a b l e p e r m i
t s , fo r e x a m p l e , o n e m u s t f i r st4 0 E I A R E V I
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d e t e r m i n e w h e t h e r a c o m p e t i t i v e m a r k
e t i n l ic e n se s w i l l ev o l ve , a n dh o w s u c h a m a
r k e t i s li k e l y to o p e r a t e . I n e f f e ct , t h e a
n a l y s i s r e q u i r e so n e t o s i m u l a t e t h e b e h
a v i o r o f f i r m s i n a c o m p l e t e l y n e w e c o n o m
i ce n v i r o n m e n t , a n d t h e n t o p re d i c t h o w t
he r e s u l t i n g i n d u s t r y w i lll o o k 3 C o s t s t u
d ie s , t h e n , c a n t ak e d i f f e re n t fo r m s d e p e n
d i n g u p o n t h eg o a l s t h e y ar e m e a n t t o se rv e .
T a b l e 1 l is ts a n u m b e r o f p o s s i b l e g o a l st h
a t s u c h s t u d i e s m i g h t h a v e . W h i l e t h e li s
t is by n o m e a n s e x h a u s t i v e ,i t d o e s g i v e s o
m e i n d i c a t i o n o f t h e r a n g e o f i s su e s th a t f
a l l u n d e r t h ec a t e g o r y o f re g u l a t o r y c o s t
a n a l y si s , a n d s h o u l d h e l p t o p r o v i d e s o m
ed i r e c t i o n f o r f u t u r e w o r k i n t h i s a r e a. N
o t e , h o w e v e r , t h a t t h e g o a l sl is te d i n T a b
l e 1 a r e n e i t h e r c o m p e t i n g n o r m u t u a l l y e
x c lu s iv e . A l lr e la te t o t h e b a si c q u e s t i o n o
f h o w p o l l u t i o n c o n t r o l s t r at e gi e s c a n b e
s tb e d e s i g n e d a n d i m p l e m e n t e d . W h i l e t h
e g o a l s a r e t h er e f o rec o m p l e m e n t a r y ra t he
r t h a n c o m p e t i t i v e - - e a c h p r o v i d i n g u se
fu li n f o r m a t i o n o f s o m e s o r t - - w e e m p h a s i
z e a g a i n t h a t s t u d ie s w i thd i f f e r e n t g o a l
s d o n e c e s s it a t e d i f f e r e n t a n a l y t i c a l p
e r s p e c t i v e s .T A B L E 1 P O S S I B L E G O A L S O F R
E G U L A T O R YC O S T S T U D I E S
I . E s t i m a t i n g R e s o u r c e C o s t s9 T o t a l r e
s o u r ce c o st s to s o ci e ty o f c o m p l y i n gw i t h e n
v i r o n m e n t a l s t a n d a rd s9 T o t a l p r i v a t e c
os ts t o p r o d u c e r s a n d c o n s u m e r so f c o m p l y
i n g w i th e n v i r o n m e n t a l s t an d a rd s9 I n d i r e
c t ef fe c ts o f r e g u l a t i o n o n p r o d u c t i v i t y
.a n d i n n o v a t i o n
I I . E s t i m a t i n g D i s t r i b u t i o n a l I m p a c
t s9 P r i c e c o n s e q u e n c e s o f c o m p l i a n c e f o
rc o n s u m e r s9 I n t r a i n d u s t r y c o m p e t i t i v e
ef fe cts o f r e g u l a t i o n9 I n t e r i n d u s t r y c o m
p e t i t i v e ef fe ct s o f r e g u l a t i o n9 I n t e r n a t
i o n a l c o m p e t i t i v e ef fe cts o f r e g u l a t i o n9
D i f f e r e n t i a l i m p a c t s b y s iz e o f f i r m9 D i f
fe r en t ia l r e g i o n a l g r o w t h a n d e m p l o y m e n
te f fe c ts o f r e g u l a t i o n
, I II . E v a l u a t i n g A l t e rn a t i v e R e g u l a t
o r y R e g i m e s9 R e s o u r c e c o st s u n d e r a l t e r n
a ti v e r e g u l a t o r yr e g i m e s9 D i s t r i b u t i o n
a l i m p a c t s u n d e r a l t e rn a t i v er e g u l a to r y
r e g i m e s9 A d m i n i s t r a t i v e , m o n i t o r i n g ,
a n d e n f o r c e m e n tc o st s u n d e r a l t e r n a ti v e
r e g u l a t o r y r e g i m e s
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T H E R E S O U R C E C O S T S O F R E G U L A T I O NE f fe c
ti ve e n v i r o n m e n t a I c o n t r o l r e g u l a t i o n r
e q u i re s t h e e x p e n d i t u r e o fr e so u r c es . W h i
l e m o s t e x i s t i n g s t u d i e s h a v e r e c o g n iz e
d th e i m p o r t a n c eo f t h e s e c o s t s a n d h a v e d e
v o t e d s p e c i a l a t t e n t i o n t o m e a s u r i n g t h
e ma c c u r a t e l y , m a n y s t il l s u ff e r f r o m a v a
r ie t y o f c o n c e p t u a l a n d e m p i r i c a ls h o r t c
o m i n g s . T h i s s e c ti o n p r o v i d e s g u i d e l i n
e s f o r c o r r e c t l ye s t i m a t i n g t h e r e s ou r c e
c o st s o f r e g u l a t i o n , e x p a n d i n g a n d i m p r
o v i n go n t e c h n i q u e s u s e d i n t h e l i m i t e d s
e t o f i n d u s t r y s t u d i e s n o wa v a i l a b l e . 3 T
o e s t a b l i sh a f r a m e w o r k f o r t h e a n a l y s i s,
w e f i rs t d e v e l o p as i m p l e e c o n o m i c m o d e l b
a s ed o n c o m p a r a t i v e s t at ic s (a t e c h n i q u e t
h a tc o m p a r e s e q u i l i b r i u m p o s i t i o n s a t d
i f f e r e n t p o i n t s i n t i m e , w h i l ei g n o r i n g
t h e p a t h a n d s e q u e n c e o f r e q u i r e d a d j u s
tm e n t s ) . W e t h e nr e v i e w t h e l i m i t a t i o n s o
f e x i s t i n g c os t st u d ie s , a n d c o n s i d e r a n u
m b e ro f m e t h o d o l o g i c a l i s s ue s i n g r e a t e r
d e t a i l .A F r a m e w o r k f o r A n a l y s i sI t i s w i d
e l y k n o w n t h a t e n v i r o n m e n t a l r e g u l a t i o
n s , b y r e q u i r i n gp r o d u c e r s t o d i v e r t r e s
o u r c e s f r o m a l t e r n a t i v e u s e s , i m p o s e r e
a lr e s o u r c e c o s t s o n s o c i e ty . W h a t i s l e ss
o f t e n r e a l i z e d is t h a t t h e s e c o s t sn e a r l y
a h v a y s e x ce e d f i rm s ' a c t u a l o u t l a y s f or c
o n t ro l e q u i p m e n t a n do p e r a t i n g e x p e ns e s
. B e c a us e of p o l l u t i o n c o n t r o ls , f o r e x a m
p l e , s o m er e s o u rc e s w i l l t r a n s f e r o u t o f t
h e r e g u l a t e d i n d u s t r i e s e n t i re l y . T h e s
es o c ia l c os ts a r e j u s t a s i m p o r t a n t a s o u t -
o f - p o c k e t e x p e n d i t u r e s , a n dm u s t b e i n c
l u d e d i n a c o m p l e t e a c c o u n t i n g o f r e g u l a
t i o n ' s r e s o ur c ecos ts . F i g u r e 1 i l l u st r a t e
s t h e se p o i n t s f o r a h y p o t h e t i c a l i n d u s t
r y . I nt h e d i a g r a m , D r e p r e s e n ts t h e d e m a n
d c u r v e f a c i n g t h e i n d u s t r y , S~ t h ei n d u s t
r y s u p p l y c u r v e p r i o r t o t h e i m p o s i t i o n o
f e n v i r o n m e n t a lr e g u l a t i o n s , a n d $2 th e i
n d u s t r y s u p p l y c u r v e a f te r re g u l a t i o n s h
a v eb e e n i m p o s e d . T h e s u p p l y c u r v e h a s s h
i ft e d u p w a r d a n d t o t h e l ef tb e c a u s e f ir m s n
o w f ac e h i g h e r p e r u n i t p r o d u c t i o n c o s ts a
s th e re s u l t o ft i g h t e n e d e n v i r o n m e n t a l q
u a l i t y s t a n d a r d s .T h r e e i m p o r t a n t a s s u
m p t i o n s h a v e b e e n b u i l t i n t o t h i s m o d e l
.T h e f ir st is th a t i n d u s t r y d e m a n d w i l l r e m
a i n u n c h a n g e d , e ve n a s t h es u p p l y c u r v e s
hi ft s. T h e s e c o n d a s s u m p t i o n is m o r e f u n d a
m e n t a l , a n dr el a te s to t h e u p w a r d s h if t i n t
h e i n d u s t r y s u p p l y c u r v e . T h i s u p w a r ds h
i f t ( t h e v e r t i c a l d i s t a n c e b e t w e e n $2 a n
d S I) r e f le c t s th e i n c r e a s e dp r o d u c t i o n c o
s t s i n c u r r e d b y i n d i v i d u a l p r o d u c e r s b e
c a u s e o fr e g u l a t i o n . T h e s h i f t i s n o t u n i
f o r m a t a l l 1 5 o i n t s a l o n g S l b e c a u s ed i ff e
r e nt p r o d u c e r s i n a n i n d u s t r y t y p i c a ll y e
m p l o y d i f fe r e n tt e c h n o l o g i e s , p o ss e ss p l
a n t s a n d e q u i p m e n t o f d i f f e r e n t v i n t a g e
s ,m a n u f a c t u r e d i f f e re n t p r o d u c t m i x e s ,
a n d t h u s f a c e d i f f e r e n t c o s ts o fc o m p l i a n
c e . 4 T o t h e e x t e n t t h a t t h e r e a r e s y s t e m a
t i c d if f e re n c e s i n t h e sec o s t s - - a s b e t w e e
n s m a l l a n d l a r g e p r o d u c e r s , o r b e t w e e n p
r o d u c e r sl o c a te d i n d i ff e re n t g e o g r a p h i c
a l r e g i o n s m e n v i r o n m e n t a l r e g u l a t i o n
sh a ve i m p o r t a n t d i s tr i b u t i o n a l i m p l i c a
t i o n s . T h e t h ir d a s s u m p t i o ni m p l i c i t i n F
i g u r e 1 is th a t t h e t im e p a t h o f a d j u s t m e n t
a n i n d u s t r yf o l l o w s i n a c h i e v i n g r e g u l a
t o r y c o m p l i a n c e c a n b e i g n o r e d .4 2 E I A R EV
I EW 2 /1
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I n r e a li t y , o f c o u r s e , d e m a n d c u r v e s s h
i f t o v e r t i m e a s t il ee c o n o m y g r o w s o r c o n t
r a c t s a n d c o n s u m e r p r e fe r en c es s h if t. S h o
r t - r u ns u p p l y c u r v e s a l s o a d j u s t a s o l d f
a c i l i t i e s a r e r e t i r e d a n d i n v e s t m e n t sa
r e m a d e i n n e w f a ci li ti es , w h i l e l o n g - r u n s
u p p l y c u r v e s s h i ft a s f ac t o rp r ic e s c h a n g e
a n d n e w t e c h n o l o g i e s a r e d e v e l o p e d .
P r i c e$2
P ~ " - : ~ N ' c
P l
FE
I It II iI II II II II IQ 2 Q , .
S:l
D
O u t p u tFi g u r e 1 T h e P r i c e a n d O u t p u t E ff
ec ts o f R e g u l a t i o n
D :S l :$2:P 2 - P I :
Q , - Q ~ :E F C A :
A B G :B C G :
D e m a n d c u r v e b ef o re a n d a f t er r e g u l a t i o
nS u p p l y c u r v e b ef o re r e g u l a t i o nS u p p l y c u
r ve a ft e r i m p o s i t i o n o f re g u l a t i o nP r i c e i
n cr e a s e d u e t o r e g u l a t i o nQ u a n t i t y d e c r e
a s e d u e t o r e g u l a t i o nO u t - o f - p o c k e t e x p
e n d i t u r e s f or p o l l u t i o nc o n t r o lF o r e g o n
e p r o d f i c e r s ' s u r p l u sF o r e g o n e c o n s u m e
r s ' s u r p l u s
E I A R E V I E W 2 /1 4 3
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Figure 1 abstracts fr om these realities strictly for
expositiona lconvenience. Th e abstraction from dynamics in no way
undercuts thequalitative co nclusions that can be drawn fro m
Figure 1, al th ou gh as alater discussion indicates, the
quantitative conclusions do changesomewhat when these dynamic
factors are fully considered.Given the assumptions made in
constructing Figure 1,producers' total out-of-pocke t expend itures
for poll utio n contr ol willbe equal to the area outlined by the
points E,F,C, and A. Th e in dustrydemand curve (or at the very
least, some measure of the elasticity ofdem and for the industr y's
products) is essential to this analysis, for thearea EFCA can only
be calculated if we know how much quantitydemanded will fall in the
face of higher prices. Only if industrydem and were perfectly
inelastic (i.e., if the dem and curve were vertical)would there be
no reduction in quantity demanded.Th e area EFCA, however, does not
reflect the total resou rce costsof regula tion. To arrive at that
value, we must add the tri angu lar area
ABC, which is the sum of the foregone producers' (ABG)
andconsumers' (BCG) surplus attributable to regulation. These
trianglesreflect real values lost. At the old price (P~), some
consumers werereceiving goods at a price less than they were
actually willi ng to pay,while some producers were receiving prices
greater than actuallyrequired to induce them to enter the market.
With the advent ofregulation, resources transfer out of the
industry, because someconsumers are no longer willing to purchase
the product at its higherprice, and some producers are no longer
able to cover their expensesand still earn a competitive rate of
return. T he s e resource transfersrepresent real values forgone
because both produce rs and co nsume rsare being denied
opportunities that would otherwise be open to them.Noneconomists
often have considerable difficulty with theseconcepts, viewing them
as less important than the seemingly moretangible out-of-pocket
costs resulting from regulation. An extremeexample may help to
demonstrate the weaknesses of that line ofthinking.Electric
utilities are widely recognized as a m ajor source of airpollution.
Suppose that rather than requiring scrubbers or theburning of low
sulfur coal, the Environmental Protection Agency(EPA) were instead
to rule that all power plants be immedia tel y closed.One result of
that action would be a sharp i mprove ment in ambi ent airquality,
without utilities having incurred hig.her operating costs
andwithout their having purchased expensive pollution controlequi
pment. By the usual measures, firms in the indust ry wou ld not
beincurr ing any c ompliance costs because their
out-of-pocketexpenditure s wo uld be zero. Can o ne therefore
conclude that this is acostless approach to reducing a major point
source of pollution?Of course not. The closing of power plants
would forceresources out of the produ cti on of electricity, and
into the pro duc tio nof more costly power sources. The real
resource costs of such astrategy i as measur ed by the su m of
producers' and cons umers 'surplus fo rgo ne -- would be enormous,
far exceeding the out-of-pocket
44 EIA REVIEW 2/1
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e x p e n d i t u r e s f o r e i t h e r s c r u b b e r s o r
c o s t ly l o w s u l f u r c o a l. I t is f o rp r e c i s el y
t h e s e r e a s o n s t h a t t h e a p p r o a c h h a s n e v e
r b e e n s e r i o u s l ys u g g e s t e d , a n d i t is f o r t
h e v e ry s a m e r e a s o n s t h a t w e b e l ie v e c h a n g
e s i np r o d u c e r s ' a n d c o n s u m e r s ' s u r p l u s
s h o u l d b e d i re c tl y e st i m a t e d inr e g u l a t o r
y c o s t s tu d i es . W e e m p h a s i z e t h i s p o i n t o n
l y b e c a u s e i t is soo f t e n o v e r l o o k e d i n p o l
i c y d eb a t e s . A n a l y s t s t y p i c a l ly f o c u s o n
o u t - o f -p o c k e t c o m p l i a n c e c o sts , a n d i g n
o r e t h e f a c t t h a t e n v i r o n m e n t a lr e g u l a t
i o n s m a y e n c o u r a g e r e s o u rc e s t o tr a n s fe r
o u t o f a n i n d u s t r y .T h i s p o i n t is p a r t i c u l
a r l y r e l e v a n t t o a s s e s s m e n t s o f t h e N e w S
o u r c eP e r f o r m a n c e S t a n d a r d s ( N S P S ) , w h
i c h w e a d d re s s i n a la t er s e c ti o n .I t is a ls o i
m p o r t a n t t o s tr es s t h a t t h e p r o d u c t i o n o f
f ew e r g o o d si n o n e i n d u s t r y d o e s n o t n e c e
ss a r il y m e a n a n e t s a v i n g s in r e s o u r c e u sef
o r s o c i e t y a s a w h o l e , f o r t h e t r a n s f e r r e
d r e s o u r c e s w i l l l i k e l y b e u s e d t op r o d u c
e o t h e r g o o d s a n d s e r v i c e s - - i t e m s w o r t h
l es s t o t h e c o n s u m e rt h a n t h o s e f o r g o n e . B
e c a u se n o t a n g i b l e r e s o u r c e s ar e p h y s i c a
l l y s a v e db y c o n t r a c t i n g a n y p a r t i c u l a r
i n d u s t r y , i t c a n n o t b e a r g u e d t h a t l o w e
ro u t p u t h a s t h e o f f se t t in g a d v a n t a g e o f c
o n s e r v i n g s c a rc e re s o u r c e s f o rf u t u r e u s
e .T h i s s i m p l e t h e o r e t ic a l a n a l y s i s h a s a
n u m b e r o f p r a c t ic a li m p l i c a t i o n s . F i rs t
, i t s u g g e s t s t h a t a n al y s t s m u s t e s t i m a t
e b o t h s u p p l ya n d d e m a n d c u r v e s i f th e y ar e
t o m e a s u r e r e s o u r c e c o s ts a c c u r a t el y .O t
h e r w i s e , t h e t h e o r e ti c a l c o n s t r u c t s o f
t h e f o r g o n e p r o d u c e r s ' a n dc o n s u m e r s ' s
u r p l u s c a n n o t b e a c c o u n t e d f or , l e a d i n g
t o a nu n d e r s t a t e m e n t o f c o m p l i a n c e c os ts
. W h i l e t h e m a g n i t u d e , a n d , h e n c e ,t h e p o
l ic y s i g n i f i ca n c e o f th i s u n d e r s t a t e m e n
t i s p r e s e n t l y u n c l e a r , o n es h o u l d n o t c o
n c l u d e t h a t t h e e s t i m a t i o n o f s u c h s u r p l
u s e s is m e r e l y a ni n t e l le c t u a l n i ce ty . A n o
t h e r e x a m p l e w i l l r e i n f o rc e t h i s p o i n t .C
o n s i d e r t h e E P A ' s r e ce n t b a n o n t h e u s e o f
f l u o r o c a r b o n p r o p e l l a n t si n a e r o s o l p r
o d u c t s . W h i l e t h e a l t e r n a t iv e t e c h n o l o
g i e s d e v e l o p e d t or e p la c e f l u o r o c a r b o n s
h a v e , f o r th e m o s t p a r t , e n t a i l e d l o w e r r
es o u r c ec o s ts , t h is d o e s n o t i m p l y t h a t t h e
s o c i a l c o st s o f t h e r e g u l a t i o n a r en e g a t
iv e . C o n s u m e r s h a v e l o s t t h e u t i l it y o f c e
r t a i n p r o d u c t a t t r i b u t e sa t t a i n a b l e t h
r o u g h t h e u s e o f t h e f l u o r o c a r b o n - b a s e d
t e c h n o l o g y , a l o ssd i f f i c u l t t o q u a n t i f y
b u t l i k e l y t o b e o f s u b s t a n t i a l s iz e.A n o t
h e r i m p o r t a n t i m p l i c a t i o n o f F i g u r e 1 is
th a t t h e p r ic ee ff ec ts o f r e g u l a t i o n r e fl ec t
t h e c o m p l i a n c e c o s t s f a c i n g t h e m a r g i n a
lp r o d u c e r i n a n i n d u s t r y , ra t h e r t h a n s o m
e a v e ra g e p r o d u c e r . ( T h e t e rm" m a r g i n a l p
r o d u c e r " s h o u l d n o t b e i n t e r p r e t e d to m e
a n a n a n t i q u a t e df i r m a b o u t t o g o o u t o f bu s
in e s s . A s e m p l o y e d h e re , m a r g i n a l f i rm s a
ree a r n i n g a c c e p t a b l e r e t u r n s o n t h e i r c a
p i t a l , a l t h o u g h o t h e r f i r m s in t h ei n d u s t
r y a r e l i k e ly t o b e r e c e i v in g h i g h e r r e t u r
n s .) A c c o r d i n g t o F i g u r e1 , t h e p r i c e i n c r
e a s e ( P 2 - P ~ ) a t t r i b u t a b l e t o n e w e n v i r o
n m e n t a ls t a n d a r d s r e s u l ts f r o m t h e i n t e r
a c t i o n o f t h e e l a s ti c i t y o f d e m a n d w i t ht h
e c o n t r o l c o st s i n c u r r e d b y t h a t p r o d u c e
r j u s t a b le t o r e m a i n i n t h ei n d u s t r y a n d s t
il l e a r n a c o m p e t i t i v e r a t e o f r e t u r n ( t h
e v e r t ic a l d i s t a n c eA C ) . T h i s , o f co u r s e ,
is t h e m a r g i n a l p r o d u c e r . A v e r a g e c o s ts
ofc o m p l i a n c e , e s t i m a t ed f o r s o m e " r e p r e
s e n t a t iv e " f i rm , t e ll u s n o t h i n ga b o u t t h e
p r i c e i n c re a s e t h a t c o n s u m e r s w i l l f ac e.
E c o n o m e t r i c m o d e l st h a t e m p l o y t he s e c o n
v e n t i o n s , a n d t h e n a rb i t ra r i ly a s s u m e a c
o m p l e t e
E I A R E V I E W 2 /1 4 5
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p a s s - t h r o u g h o f c o s ts , a r e c e r t a i n t o b
e i n e r ro r .B e c a u s e i n d u s t r i e s a r e c o m p o s
e d o f p r o d u c e r s w i t h w i d e l yv a r y i n g c h a r
a c t e r i s t i c s , c o s t s t u d i e s m u s t b e b a s e d
o n d i s a g g r e g a t e dc o s t d a t a i f th e y a re t o c
a p t u r e t h e d i f f e r e n t i a l u p w a r d s h i f t i n
t h es u p p l y c u r v e . T h i s p o i n t i s i m p o r t a n
t , b e c a u s e es t i m a t e s o f p l a n t -s p e ci fi c c o
m p l i a n c e c o s ts p r o v i d e t h e r a w m a t e r i a l
f o r a d d r e s s i n g an u m b e r o f c r it i c a l d i s t r
i b u t i o n a l i s su e s . If th e s e c o s t s a r e a g g r
e g a t e d b ys i z e c l a s s e s o f f i r m s , f o r e x a m
p l e , w e c a n d e t e r m i n e w h e t h e r s c a l ee c o n
o m i e s r e su l t fr o m e n v i r o n m e n t a l r e g u l a t
io n s , a n d w h e t h e r s m a l lf i r m s t h e n f ac e s i
g n i f i c a n t c o s t d i s a d v a n t a g e s . I f t h e s e
c o s t s ~ /rea n a ly z e d b y p l a n t l o c a ti o n , w e c
an d e t e r m i n e w h e t h e r t h e re a rer e g i o n a l d i
ff e re n c e s i n c o m p l i a n c e c o s ts . F i n a l ly , i
f th e m a r g i n a l c o s tso f c o m p l i a n c e a r e p l o
t t e d f o r i n d i v i d u a l p l a n t s i n a n i n d u s t r
y , w e c a no b se rv e b o t h t he i n t r a i n d u s t r y c o
m p e t i t iv e i m p a c t s o f r e g u l a t i o n s , a n dc a
n i d e n t i f y t h o s e p l a n t s l i k e l y t o c l o s e b
e c a u s e o f t h e i r i n a b i l i t y t om e e t m a n d a t
e d s t a n d ar d s w i t h o u t i n c u r r i n g e xc es si ve
ly h i g h c o st s.
T h e c o m p l i a n c e c o s ts i n c u r r e d b y i n d i v
i d u a l f a ci li ti e s, t h e n , a r et h e ~d ea l b u i l d
i n g b l o c k s f o r a s s e s s i n g b o t h t h e r e s o u r
c e c o s ts a n d t h ed i s t r i b u t io n a l i m p a c t s o
f n e w r e g u l a ti o n s . O f c o ur s e , a c t u a li n f o
r m a t i o n i s n o t a l w a y s a v a il a b l e o n a l l p r
o d u c e r s i n a n i n d u s t r y . I nt h o s e c as e s, r e
p r e s e n t a t i v e c o s t d a t a c a n b e u s e d f o r d i
f f e r e n t c a t e g o r i e so f p ro d u c e r s t o a p p r o
x i m a t e t h e u p w a r d s h i f t i n t h e s u p p l y c u r
v e .P r o v i d i n g p r o d u c e r s a re a s s i g n e d to t
h e co r re c t c a t e g o r i e s - - a ne x t r em e l y d i f f
ic u l t ta sk , g i v e n o u r i m p e r f e c t k n o w l e d g
e a b o u t t h ea s s o c i a t i o n o f s p e c i fi c p r o d u
c e r c h a r a c t e r i s t i c s w i t h d i f f e r i n g l e v
e ls o fc o m p l i a n c e c o s t s - - t h a t a n a l y s i s s
h o u l d g e n e r a t e r e a s o n a b l y r e l i a b l ee s t
i m a t e s .
A t t h i s p o i n t , i t is i m p o r t a n t t o be a b i t
m o r e e x a c t i n g i nd e f i n i n g t h e c o n t r o l c o
s ts t h a t r e s u lt f r o m r e g u l a t i o n . F i rs t , a
n a l y s t ss h o u l d b e c a re f u l t o s e p ar a te o u t l
a y s f o r c o n t r o l e q u i p m e n t f r o m o t h e ri n v
e s t m e n t s i n f a ci li ti es m a d e a t t h e s a m e t i m
e . T o t h e e x t e n t t h a t t h et e c h n o l o g i e s i n
v o l v e d a r e t r u l y s e p a r a b l e , t h i s i s a r e l
a t iv e l y s i m p l eta sk , r e q u i r i n g f e w a s s u m p
t i o n s . W h e r e . j o i n t c o st s a re i n v o l v e d ,h
o w e v e r , t he p r o b l e m b e c o m e s c o n s i d er a b l
y m o r e d i f f i c u lt , a n d m a yn e c e ss i ta t e t h e u
s e o f v a r i o u s c o s t a c c o u n t i n g f o r m u l a s f
o r a l l o c a t i n go v e r h e a d . 5 B e c a u se t h es e f
o r m u l a s a r e e x c e e d i n g l y c o m p l e x , a n ds e
l d o m b e a r a c lo s e c o r r e s p o n d e n c e t o t h e e
c o n o m i c c o n c e p t o f c o s t s ,t he s e e s ti m a t e
s a r e u n l i k e l y t o b e e sp e c i a ll y a c c u r at e .
C o n f i d e n c eb a n d s , r a th e r t h a n p o i n t e s ti
m a te s , w o u l d b e e s p ec i al ly a p p r o p r i a t e i
nt he s e c i r c u m s t a n c e s .T h e j o i n t c o st p r o b
l e m is f u r th e r c o m p l i c a t e d b y q u e s t i o n s o
ft im i n g . T o t he e x te n t t h a t i n ve s t m e n ts i n c
o n tr o l e q u i p m e n t a n d o t h e rc a p i t a l f a c i l
i t i e s a r e t r u l y i n d i v i s i b l e , p r o d u c e r s
m a y f i n d ex pos tu p g r a d i n g o f th e i r c o n t r o l
e q u i p m e n t e x tr e m e l y e x p e n si v e . F a c e d w i
t ha r e a so n a b l e p r o b a b i l i t y o f i n c r e a s i n
g l y s tr i n g e n t e m i s s i o n s s t a n d a r d s ,p r o d
u c e r s m i g h t t h er e fo r e d e c id e t o i n s ta l l c o
st ly c o n t r o l e q u i p m e n tb e f or e n e w s t a n d a r
d s w e r e e n a ct e d . A s a r e s u lt , t h e i r i n c r e m
e n t a l o u t -o f - p o c k e t c o m p l i a n c e c o s ts a f
te r t h e n e w s t a n d a r d s w e r e p a s s e d w o u l db e
q u i t e l o w . I n t h es e c i r c u m s t a n c e s , a n a l
y s t s n e e d to a d d t h e e a r l i e r4 ~ E I A R E V I E W 2
/ 1
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invest ment costs to those incurred after the enac tment of the
standardsin or der to measu re the full costs of com pli anc e. Of
course, the reverseholds true as we ll . Analysts need to be sure
that they disti nguishinvestments that would have been made in the
absence of regul ationsfrom those that were clearly prompted by
them. Once again, detailedknowledge of individual producer behavior
is required.Issues of timing and joint costs, while appearing to be
meresubtleties of cost analysis, are in fact the objects of cons
iderable policyattenti on. For example, it is freq uentl y
suggested that someregulations "pay for themselves," actually
lowering an industry'ssupply curve by bringing to mana geme nt's
attention new technologiesand methods of cost control, which would
not otherwise be utilized.While there is some truth to these argu
ment s, one can not use them toinfer that regulation is costless,
since cost-saving technologies couldpresumably have been identified
by someone--a public agency, forexample--without mandating
regulatory compliance. More often,the concern is with the potential
oversta tement of comp lia nce coststhat results when technological
advances and other cost-reducingmethods are employed that were
unforeseen at the time of the costanalysis. Th is conce rn suggests
that analysts, con fro nti ng a necessarilyfinite list of comp
liance alternatives, should recognize that the low costalternatives
on that list are likely to be high-side estimates of
actualout-of-pocket compliance costs.In addition, there is often
considerable debate as to whatconstitutes the relevant base for
cost compa riso n. In m an y cases, stateregulations "boot strap"
federal standards, main tai ning the latter as afloor (e.g., air
quality regulation in California). This makes itextremel y
difficult to establish the base from which an indust ry'ssupply
curve shifts due to the regulat ory actions of any individu
algovernme nt agency.Th e above analysis, based on a simpl e
comparat ive static modelprovides a general framework for assessing
the resource costs ofregulation. Despite its obvious utility, the
model has a number ofimp ort ant limitations . First, because the
analysis is based solely onshifts in s upply and deman d curves, it
ignores those resource costs thatare not incurred directly by firms
in the regulated industry.Environmental regulations, however, also
involve administrative,monitor ing, and enforce ment costs because
complia nce by firms is notautomatic. These costs, which are borne
largely by local, state, andfederal government s, mu st be added to
the out-6f-pocket expen diture sof producers and to the lost cons
umers ' and producers' surpl us in orderto determi ne the total
resource costs of air emissions standards.Perhaps the most troubles
ome of these costs for the analyst arethe tax effects of regula
tion. T he vertical shift in an industry 's supplycurve can be inf
luenced by the existence of d i f f e r e n t i a l tax treat ment
ofregula tory compl ianc e costs. 6 To the extent that taxes
distort the trueresource costs of regulatory compliance, the fiscal
implications ofregul ation are impor tant . Th ese distortions, it
should be stressed, workin both directions. On the one hand,
special write-off provisions for
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comp liance costs result in producers' out-of-p ocket costs unde
rsta tingtotal resource costs. On the other hand , tax revenues can
rise withcomp liance (e.g., highe r prope rty tax revenues due to
capital intensit yof control technologies) witho ut the highe r tax
costs reflecting a realresource use by society.On balance, there
seems to be little need at present for asophisticated treatm ent of
tax issues in most r egulat ory cost studies.Only in regulated
industries like public utilitiesmwhere taxesmaterially influence
patterns of cash flows--or industries likepetroleum ref ini ng- -wh
ere substantial excise taxes exi st- -wo uldsuch analyses generally
be required.The re are three reasons for this rec ommenda tion .
First, as notedabove, some of the tax effects are offsetting.
Second, comp li anc e costswithout tax effects reflect the real
resource costs to society ofenv iron ment al controls, the
incidence of the costs due to the tax systemnotwiths tand ing. Thi
rd, since the tax effects result from differential
tax rates, they involve a degree of analytical subtlety and
sophisti cationnot yet matched in other areas of cost
investigation.In addit ion, because the model discussed in this
section relies oncompara tive statics to generate its results, the
time path of adju stment,possible strategic responses, and cost
reduc tion th rou gh t echnolog icalinnov atio n are all ignored.
As a result, the shape of the supp ly curveafter new reg ulation s
have been imposed, as well as the mag nit ude ofthe upward shift in
the curve, are both subject to considerableuncertainty. In certain
environments, these technological effects,which reflect dynamic
adjustments, will swamp those estimated bycomparative statics. For
that reason, some estimate of these effectsshould be attempted
whenever possible, although we are unable tooffer much guidance on
the precise form that they should take.The same can be said of
general equilibrium effects. If thedemand curve in Figure 1, for
example, were to represent a deriveddemand--the demand for steel,
perhaps, or for some other rawmaterial -- a shift in relative
factor prices due to regulati on (reflected inthe up ward shift in
the suppl y curve f rom S~ to S2,',with n o cha nge inthe cost of
competing raw materials) would lead to substitution awayfrom the
now more expensive input. Over time, this would prod uce adownw ard
shift in the demand curve as firms altered their
productionprocesses and developed new technologies, reduci ng the
estimate of thesocial costs of regulation derived from partial
analysis. Because theinclus ion of such general equ ili bri um
effects provides a more accuratemeasure of long-run compliance
costs, they should be estimatedwhenever possible. Here again,
however, the analytical difficulties areoften intractable, although
linear prog ramm ing and input- outputmodels can occasionally be
used to approxi mate general equi libr iumadjustments.Before consi
derin g further me thodo logic al issues, it is useful tocontrast
the framework presented above with the features of manyexisting
cost studies.
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E x i s t in g S t u d i es o f t h e C o s ts o f R e g u l a t
i o n 7F e w e x i s t i n g s t u d i e s h a v e a c t u a l l y
e s t i m a t e d i n d u s t r y s u p p l y a n dd e m a n d c u
r v e s , a n d f e w e r s t i l l h a v e i n c l u d e d e s t i
m a t e s o f f o r e g o n ec o n s u m e r s ' a n d p r o d u c
e r s ' s u r p l u s . I n s t ea d , m o s t h a v e e m p l o y
e d a ne n g i n e e r i n g o r a c c o u n t i n g c o s t a p p
r o a c h , f o r ec a s ti n g f u tu r e o u t p u t ,
s o m e t i m e s a d j u s t i n g t h a t e s t im a t e t o
re f le c t d e m a n d e l as t ic i ti e s, a n dt h e n m u l t
i p l y i n g i t by e x p ec t ed c o n t r o l c os ts p e r u n
i t o f o u t p u t t oa r ri v e a t a n a g g r e g a t e m e a s
u r e o f t h e c os ts d u e t o r e g u l a t i o n . A sC r a n
d a l l p o i n t s o u t , t w o b a s i c a p p r o a c h e s h a
v e b e en u s e d t o c a l c u l a tec o n t r o l c o st s:
T h e f ir st a d d s t o a " b a s e l i n e " c o s t o f p r
o d u c t i o n t h e s te a d y -s t at e f l o ws d f f i c i e n
t t o a m o r t i z e a l l c a p i t a l i n v e s t m e n t s i n
c o n t r o l f a c i l it i esp l u s t h e v a ri a b le c o st s
o f c o n t r o l l i n g t h e e n v i r o n m e n t a l d i s c h
ar g e s .T h e s e c o n d e v a lu a t e s t h e " r e v e n u e
s r e q u i r e m e n t s " o v e r t h e l if e o ft h e f ir m '
s c a p i t a l e q u i p m e n t f o r c o n t r o l l i n g t h
es e d is c h a r g e s , sN e i t h e r m e t h o d a d e q u a t
e l y c a p t u r es o u t p u t e f fe cts ( t h e r e d u c t io
n o fo u t p u t f r o m O t o Q 2 , in F i g . I) , a n d n e i t
h e r t ak e s a n y a c c o u n t o f t h ef o r e g o n e c o n s
u m e r s ' a n d p r o d u c e r s ' s u r p l u s . M o r e o v
er , th e d i s c o u n tr a te s u s e d i n a s s e s s i n g t h
e p r e s e n t v a l u e o f c o n t r o l c o s t s h a v e g e n
e r a l l yb e e n s et e q u a l t o r e c e n t r e tu r n s i n
t h e i n d u s t r y b e i n g s t u d i e d . N o t o n l yd o t
h e s e m e a s u r e s f a i l t o c a p t u r e d i f f e r en c
e s i n ri s k s a c r o s s i n d u s t r i e s ,t h e y a l s o f
a i l t o d i s t i n g u i s h b e t w e e n m a r g i n a l a n d
a v e r a g e c o s t s o fc a p i t a l .A t t h e s a m e t i m e
, m a n y o f t h es e st u d i e s h a v e o v e r s t at e d t h
e p r ic ee ff ec ts o f r e g u l a t io n b y i g n o r i n g p o
s s i b l e i m p o r t s u b s t i t u t i o n .E s p e c i a l l
y i n b a s i c r a w m a t e r i a l s o r p r o c e s s i n d u s
t r i e s , t h e r e a r e w e ll -d e v e l o p e d i n t e r n a
t i o n a l m a r k e t s a n d s t r o n g i n t e r n a t i o n a
lc o m p e t i t i o n . W h i le e n v i r o n m e n t a l r e g u
l a t i o n s w i l l le a d to h i g h e rp r o d u c t i o n c o
st s f o r d o m e s t i c p r o d u c e r s , p r i c e e ff ec ts
w i l l b e m i t i g a t e db y t h e ex i s te n c e o f f o r e
i g n s u p p l i e r s . T h e i r p r e ci s e i m p a c t w i l
l d e p e n do n t h e e l a st ic i ty o f f o r e i g n s u p p l
y a n d o n t h e l o n g - r u n s u p p l y p r ic e( i n c l u d
i n g t r a n s p o r t a t i o n c o st s) o f f o r e i g n p r o
d u c e r s .U n f o r t u n a t e l y , i t is im p o s s i b l e
t o c o n c l u d e f r o m t h is a n a l y s i sw h e t h e r e x
i s t i n g s t u d i e s h a v e o v e r o r u n d e r e s t i m a
t e d t h e r e s o u r c e c o s tso f r e g u l a t i o n . W h i
l e b i a s e s ar e c l e a r ly p r e s e n t , t h e y ar e n e
i t h e rs y s te m a t i c n o r u n i f o r m . T h e n e g l ec
t o f c o n s u m e r s ' a n d p r o d u c e r s 's u r p l u s ,
fo r e x a m p l e , w o u l d s u g g e s t a n u n d e r s t a t
e m e n t o f c o m p l i a n c ec o st s, as w o u l d t h e i n t
e r e s t r a te s e m p l o y e d . 9 E q u a l l y i m p o r t a
n t ,h o w e v e r , a n d p u s h i n g i n t h e o p p o s i t e
d i r e c ti o n , w o u l d b e th e n e g le c to f t e c h n o
lo g i c a l i n n o v a t i o n a n d o t h e r d y n a m i c a d
j u s t m e n t s , a n d t h ei n c e n t i v e s t h a t f i r m
s h a v e t o o v e r s t a t e t h e i r a n t i c i p a t e d c o
n t r o l c o s t s .O n b a l a n c e , i t is d i f f i c u l t t
o sa y w h i c h o f t h e s e e f fe c ts d o m i n a t e s .T h e
L i m i t a t i o n s o f C o s t A n a l y s i sB e c a us e c o s
t a n a l y s i s is s u c h a n i m p o r t a n t i n p u t i n t
o t h e r e g u l a t o r yp r o c es s , w e c o n c l u d e t h i
s s e c t io n w i t h a d i s c u s s i o n o f it s l i m i t a t
i o n s .S o m e o f t h e se l i m i t a t i o n s a r e d i c t a
t e d b y t h e p a u c i t y o f r e l ev a n t d a t a ,
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w h i l e o t h e r s r e s u l t f r o m m e t h o d o l o g i
c a l w e a k n e s s e s .F r o m a s t r i c tl y a n a l y t i c
a l p o i n t o f v ie w , t h e id e a l c o s t s t u d yw o u l
d e m p l o y a d y n a m i c , ge n e r a l e q u i l i b r i u m
f r am e w o r k , a l lo w i n gf o r s p a t ia l a d j u s t m e
n t , s t r a te g i c a d a p t a t i o n s b y f i rm s , i n t e
r t e m p o r a lf a c t o r s u b s t i t u t io n , a n d t e c h
n o l o g ic a l i n n o v a t i o n . A n y s u c h m o d e l ,
ofc o u r s e , is l i k e ly t o b e h o p e l e s s l y c o m p l
e x a n d e x p e n s i v e , a n d s os e n s i t i v e t o i t s
a s s u m p t i o n s t h a t i t w o u l d b e o f l i t t l e u s
e t op o l i c y m a k e r s . A s a r e s u l t , m o s t c o s t
s t u d i e s ar e s et i n a p a r t i a le q u i l i b r i u m f
r a m e w o r k , a n d , l ik e F i g u r e 1 , r ely p r i m a r
i l y o nc o m p a r a t i v e s t at ic a n a l y s is t o g e n e
r a t e t h e i r r e su l ts . T h i s h a s a n u m b e ro f i m
p o r t a n t i m p l i c a t io n s .F i r s t, i t s u g g e s t
s t h a t m o s t e s t i m a t e s o f c o m p l i a n c e c o s
ts a r e le sse x a c t i n g t h a n t h e y fi rs t a p p e a r ,
f o r t h ey i g n o r e a v a r ie t y o f d y n a m i ca d j u s
t m e n t s o p e n t o f i rm s . M a n y o f th e se a d a p t a
t i o n s e n a b l e f ir m s toa t t a i n r e q u i r e d l ev e
ls o f e m i s s i o n s c o n t r o l a t c o n s i d e r a b l y
l o w e r c o st st h a n w o u l d b e p r e d i c te d b y a s i
m p l e a n a l y s is b as e d o n c o m p a r a t i v es t at ic
s . A t t h e s a m e t i m e , m o s t c o s t s t u d i e s h a v
e a l s o i g n o r e d v a r i o u si n t e r a c t i o n e ff ec
ts t h a t l e a d t o h i g h e r c o m p l i a n c e c o s ts . T
h e c o s ts o fc o m p l y i n g s i m u l t a n e o u s l y w i t
h a i r q u a l i t y s ta n d a r d s a n d r e g u l a t i o n si
m p o s e d b y o t h e r a g e n c ie s , fo r e x a m p l e , i s
s e l d o m t he s i m p l e s u m o ft h e co st s o f c o m p l y
i n g w i t h e a ch r e g u l a t i o n i n d i v i d u a l l y .
T h ec o m b i n e d e f fe c t o f s e ve ra l r e g u l a t i o n
s m a y l i m i t t h e r a n g e o f t e c h n i c a lc h o i c e
s fo r m e e t i n g a n y o n e r e g u l a t o r y r e q u i r e
m e n t . O n b a l a n c e , i t isd i f f i c u lt t o s a y w h
e t h e r t h e f a i l u r e t o c o n s i d e r r e s o u rc e r
e q u i r e m e n t sf o r m e e t i n g o t h e r r e s id u a l m
a n a g e m e n t g o a ls , s u c h a s t h os e fo r w a te ra n
d s o l id w a s t e, h a s l e d to a n o v e r o r u n d e r s t
a t e m e n t o f c o m p l i a n c ec o s t s in e x i s t i n g c
o s t s t u d i e s .A s th e p r e c e d i n g d i s c u s s i o n
i n d i c a t e d , m o s t e x i s t i n g s t u d ie sa l s o s u
ff e r f r o m a n u m b e r o f s e r io u s m e t h o d o l o g i
c a l w e ak n e s s es . T h ei m p o r t a n t p o i n t f o r o
u r p u r p o s e s , h o w e v e r , is t h a t all e x i s t i n
ge s t i m a t e s of c o m p l i a n c e c o s t s - - a n d , i n
a l l p r o b a b i l i t y , a ll e s t i m a t e st h a t w i l l
b e p r o v i d e d i n t h e n e a r f u t u r e - - a r e a t be
st r o u g ha p p r o x i m a t i o n s o f th e a c tu a l c o s
ts t h a t f ir m s w i l l i n c u r . W e e m p h a s i z et h is
p o i n t b e c a u s e m a n y p o l i c y m a k e r s h a v e a t
e n d e n c y to re g a r d c o s te s t i m a t es as " h a r d "
n u m b e r s , e s p ec i al ly w h e n c o m p a r e d w i t h t
heu n c e r t a i n t i e s s u r r o u n d i n g b e n e f i ts e
st m a t e s . C o s t s t u d ie s , h o w e v e r , a r ee q u a
l l y s e n s it iv e t o t h e i r a s s u m p t i o n s , a n d t
h e e s t i m a t e s th a t r e s u lt ar es e l d o m v e r y p r
e c i s e .D I S T R I B U T I O N A L I M P A C T S O F R E G U L
A T I O NW h e n p o l i c y m a k e r s e x p r e ss c o n c e r n
a b o u t t h e c o s ts o f r e g u l a t i o n , t h e yu s u a l
l y h a v e t w o r e l a te d , b u t c o n c e p t u a l l y s e
p a ra b l e , c o n s i d e r a t i o n s i nm i n d . O n e , f o
r m e r l y d i s cu s s e d , is h o w m u c h r e g u l a t i o n
w i l l c o st . T h eo t h e r , d i s c u s s e d i n t h i s s e
c t i o n , i s p r e c i s e l y w h o w i l l b e p a y i n g t h
a tc o s t . T h e r e a r e a n / ~ m b e r o f d if f e re n t w
a y s t o d e f in e t h e d i s t r i b u t i o n a li m p a c t s
o f r e g u l a t i o n . O n e w a y t h a t r e g u la t o r y c
o m p l i a n c e co s ts m a yv a ry , f o r e x a m p l e , i s b
y p l a n t s , w i t h s o m e p l a n t s i n c u r r i n g h i g
h
5 0 E I A R E V I E W 2 / i
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c o m p l i a n c e c o s ts a n d o t h e r s l o w . T h e d i
ff e r en c e i n t h e s e c o s ts is o n eo b v i o u s m e a s
u r e o f th e d i s tr i b u t i o n a l i m p a c t o f e n v i r
o n m e n t a lr e g u l a t i o n .B e c a us e t h e t h e o re t
ic a l m o d e l o f p e r fe c t c o m p e t i t i o n i m p l i e
st h a t a ll c o m p e t i t o r s i n a n i n d u s t r y f ac e
th e s a m e p r i c e fo r th e i r o u t p u t ,a r e la t e d m
e a s u r e o f d i s t r ib u t i o n a l i m p a c t i s t he d
if f e re n c e b e t w e e n a ni n d u s t r y ' s r e v e n u e
c h a n g e d u e t o r e g u l a t i o n a n d d i f f e r e n t p
r o d u c e r s 'a v e r ag e c o s ts o f c o m p l i a n c e . W
h e n c o st s h a v e be e n e s t i m a t e d a t t h ep l a n t
l e v el , i t b e c o m e s a m a t t e r o f s i m p l e a r i t
h m e t i c t o a g g r e g a t e t h es ec o s t -r e v e n u e d
if f e r en t i a ls i n s o m e f a s h i o n . T w o p o s s i b
l e b a se s fo ra g g r e g a t i o n a r e b y g e o g r a p h i
c a l r e g i o n a n d b y siz e o f f i r m . B ya g g r e g a t
i n g b o t h r e v e n u e a n d c o s t i m p a c t s t o t h e i
n d u s t r y l e ve l, it t h e nb e c o m e s p o s s i b l e t o
e s t i m a t e t h e n e t r e d i s t r i b u t i o n b e t w e e
n p r o d u c e r sa n d c o n s u m e r s i n d u c e d by r e g u
l a t i o n . F in a l ly , t h r o u g h p r o p e rd i s c o u n
t i n g o f t h e t i m e s t r e a m s o f th e s e p r i c e a n
d c o s t d i f f e r e n t i a l s , i t i sp o s s i b l e t o i
n f e r t h e i n t e r g e n e r a t i o n a l d i s t r i b u t i
o n a l e f fe c ts o fr e g u l a t i o n a s w e l l.Differential
Co m plianc e CostsI n c o n c e p t a t le as t, th e d i s t r i
b u t i o n a l i s s u e s u r r o u n d i n g c o m p l i a n c
ec o s ts i s s t r a i g h t f o r w a r d : g i v e n d i f fe r
e n ce s i n g e o g r a p h i c a l l o c a t i o n ,t e c h n o l
o g i e s , sc al e, a ge , a n d p r o d u c t m i x . a m o n g p
l a n t s , i t is h i g h l yu n l i k e l y t h a t a l l c o m p
e t i t o r s i n a g i v e n i n d u s t r y w i l l c o n f r o n
t i d e n t i ca lc o m p l i a n c e c o s ts . S o m e w i l l h
a v e h i g h c o s ts , a n d s o m e lo w . I n d e e d , i tw a
s t h es e d if f er e n c es i n c o m p l i a n c e c o s ts t h
a t l ed u s t o a s s u m e e a r li e rt h a t t h e v e r t ic a
l s h i f t in a n i n d u s t r y ' s s u p p l y c u r v e d u e
t o r e g u l a t i o nw o u l d n o t b e u n i f o r m f or al l
p r o d u c e rs . T h e c o st f u n c t i o n s n e e d e d toe s
t i m a t e s u c h v e r t i c al s h i f ts i n t h e i n d u s t
r y ' s s u p p l y c u r v e w il~u l t i m a t e l y r e st o n p
l a n t - l e v e l d a t a . S u c h d a t a n o t o n l y te llp
o l i c y m a k e r s t h e d i s t r i b u t io n o f c o m p l i
a n c e c o st s i n a n i n d u s t r y , b u tc o n t a i n o t h
e r i m p o r t a n t i n f o r m a t i o n as w el l.F o r o n e t
h i n g , p l a n t -l e v e l d a t a i n d i c a t e h o w c o s
t s a r e a s s o c ia t e dw i t h v a r i o u s p l a n t a t t r
i b u te s . I t is t h e re f o re p o s s i b le t o d e t e r m
i n ew h e t h e r c e r t a in r e g i o n s o f t h e c o u n t r
y o r f i r m s o f a p a r t i c u l a r s i ze fa ced i s p r o p
o r t i o n a t e l y h i g h o r l o w c o m p l i a n c e co st
s. T h i s i n f o r m a t i o nc a n n o t b y i t s el f e x p l
a i n t h e r e a s o n s f o r t h e se c o s t d i f f e r e n t
i a l s , b u t c a nb e a n i m p o r t a n t i n p u t i n t o s
u c h i n v e s ti g a t i o n s . F o r e x a m p l e , a f i n d
i n gt h a t o n e g r o u p o f p r o d u c e r s fa ce d p a r t
i c u l a r l y h i g h c o m p l i a n c e c o st sc o u l d t r i
g g e r a s t u d y a s t o w h y t h i s w a s t h e c a se . S u
c h a s t u d y m i g h ts h o w t h a t t h e s e h i g h c o s ts
y ie l d ed li tt le m a r g i n a l v a l u e w h e n m e a s u r
e da g a i n s t t h e r e g u l a t i o n ' s o b j ec t iv e s .
I n t h i s w ay , i n f o r m a t i o n a b o u t t h ed i s t r i
b u t i o n o f r e g u l a t o r y c o s t s c o u l d b e u s e d
t o b e t t e r e q u a t ei n c r e m e n t a l c o s t s w i t h
i n c r e m e n t a l b e n e f i t s .E x p e r i e n ce w i t h t
h e e s t i m a t i o n o f c o m p l i a n c e c o s t f u n c t i
o n ss u g g e s ts t h a t t h e y c a p t u r e a q u a l i t a t
i v e l y s i g n i f i c a n t p h e n o m e n o n .I n d e e d ,
in f i ve o f s ix i n d u s t r i e s s t u d i e d fo r t h e N a
t i o n a l C o m m i s s i o no n W a t e r Q u a l i t y w h e r
e s u c h c u r v es w e r e e s t i m a t e d , 8 0 p e r c e n t
o f t h ei n d u s t r y c a p a c i t y e x p e r i e n c e d c o
m p l i a n c e c o s t s l o w e r t h a n t h e
E I A R E V I E W 2 /1 51
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i n d u s t r y a v e r a g e , w h i l e 2 0 p e r c e n t h a
d c o s t s a b o v e t h i s f ig u r e , l~ I n a l lc a se s , t
h e f ig u r e f o r t h e i n d u s t r y ' s a v e r a g e c o s
t o f c o m p l i a n c e m a s k e ds i g n i f i c a n t d i ff e
re n c e s a m o n g c o m p e t i t o r s . I n o n e i n s t a n
c e , fo re x a m p l e , t h e 80 p e r c e n t l o w c o m p l i
a n c e c o s t c a p a c i ty w a s o w n e d a n do p e r a t e d
b y f e w e r t h a n 2 0 p e r c e n t o f t h e p r o d u c e r s
.D if f e r e n t ia l N e t R e v e n u e E f f e c t sT h e d i f
f e re n c e b e t w e e n t h e p r i c e le v el af t e r r e g u
l a t i o n (P 2 i n F i g . 1) a n dt h e p r i c e l ev e l w i t
h o u t r e g u l a t i o n ( P I ) i s t h e g r o s s r e v e n u
e a v a i l a b l e t oo f fs e t th e u n i t c o st s o f c o m p
l i a n c e . T h e n e t r e v e n u e e f fe ct f o r a n yi n d
i v i d u a l p r o d u c e r is t h e d i f fe r e n c e b e t w e
e n i ts i n d i v i d u a lc o m p l i a n c e c o s t s a n d i t
s g r o s s r e v e n u e c h a n g e d u e t o r e g u l a t i o n
.O n e s h o u l d r e c o g n iz e th a t t h e t i m i n g a n d
e x p e c t a t i o n s is s u esd i s c u s se d e a r li e r a l
s o h a v e i m p o r t a n t r e v e n u e i m p l i c a t i o n s
. F o r s h o r t -r u n e c o n o m i c a n a ly s is , i t is o n
l y t he i m p e n d i n g c o m p l i a n c e c o st s th a td e t
e r m i n e p r i c e e f f e c t s , s i n c e a n y c o s t s i n
c u r r e d i n a n t i c i p a t i o n o ff e d e r a l r u l e s
o r r e g u l a t i o n s a r e a l r e a d y s u n k . O v e r t h
e l o n g t e r m ,h o w e v e r , i t is t h e t o t a l r e p l a
c e m e n t c o s t s th a t a r e r e l e v a n t t o p r i c ed e
t e r m i n a t i o n .I t is a ls o w o r t h s t r es s i n g th
a t t h e s h a p e o f th e u n d e r l y i n g s u p p l yc u r v
e ( S l) is c r it i c al t o a n y n e t r e v e n u e c a l c u l
a t i o n . I n p a r t i c u l a r , i t i si m p o r t a n t t o
n o t e t h a t f a c il it ie s t h a t h a v e l o w p r o d u c
t i o n c o s ts (i .e ., ar eo n t h e le ft o f S t) m a y n o t
b e t h e o n e s w i t h l o w c o m p l i a n c e co s ts . T h
er e l e v a n t c o m p e t i t i v e c o n s i d e r a t i o n is
t h e n e w s u p p l y c u r v e $2 b a s e d o nt h e s u m o f p
r o d u c t i o n a n d c o m p l i a n c e c o st s. T h u s , t h
e gr o ss re v e n u ee f f e c t ( P 2 - P ~ ) a n d , c o n s e q
u e n t l y , t h e n e t r e v e n u e e f f e c t , c a n o n l y
b ed e t e r m i n e d b y k n o w i n g b o t h c o m p l i a n c
e c os ts a n d S t.T h e d i f fe r e n ce b e t w e e n t h e o l
d O j a n d t h e n e w Q / i s a m e a s u r eo f th e c u t b a c
k i n q u a n t i t y i n d u c e d by r e g u l a t i o n . G i v
e n p l a n t - l e v e ld a t a , t h i s d i f f e re n t i a l s
e rv e s t o id e n t i f y t h e i n d i v i d u a l f a c i l it
i es m o s tl i k e l y t o a b s o r b t h e se q u a n t i t y l
os s es . T h e s e f a c il it ie s a r e t h e h i g h c o s t,m
a r g i n a l f a ci li ti es in t h e in d u s t r y a n d a r e t
h u s p r i m e c a n d i d a t e s f orp l a n t c l o s i n g s
.I n r e a li t y , o f c o u r s e , a g i v e n f a c i li t y d
o e s n o t p o s s e s s a s i n g l ea v e r a g e c o m p l i a
n c e c o s t, b u t r a t h e r f ac e s a s c h e d u l e o f c o
s ts , w i t h t h ea v e r a g e v a r y i n g w i t h v o l u m e
. T h u s , t h e d i f f e re n t i a l b e t w e e n Q ~ a n d Q
iw i l l n o t b e a s s o c ia t ed u n a m b i g u o u s l y w i
t h p l a n t cl o s u re s . It isp o s s i b l e t h a t a f e w
f a c il it ie s m i g h t c l o s e w h e n c o n f r o n t e d w
i t hr e g u l a t o r y c o m p l i a n c e c o s ts , w h i l e o
t h e r s w i l l r t in o n s m a l l e r v o l u m eo r o n l y s
p o r a d i c a l l y . I n f a ct , i f p r i c e s c o n t i n u
e t o ex c e e d a v e r a g ev a r i a b l e c o s ts t h e r e w
i l l n o t b e a n y c l o s u r e s i n t h e s h o r t r u n . E
v e n i n t h el o n g r u n , c l o s u re s a re n o ~ a n e c e
s sa r y r e s u lt , p r o v i d i n g d e m a n d i sg r o w i n
g a t a s u f f ic i e n tl y r a p i d r at e.R e a g g r e g a t
i o nT h e c a l c u l a t i o n o f p r ic e , q u a n t i t y , a
n d c o s t e ff ec ts o f r e g u l a t i o n o n t h ed i s a g g
r e g a t e d b a s i s o u t l i n e d a b o v e y i e ld s d a t
a u s e f u l f o r a v a r i e ty o f
~ 9 E I A R E V I E W 2 / 1
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p o l i c y a s s e s sm e n t s , p a r t i c u l a r l y i m p
a c t b y s iz e o f f i r m a n d r e g i o n a li m p a c t s .I
m p a c t b y Siz e o f F i r m . T h e r e h a s a lw a y s b e e
n c o n s i d e r a b l e c o n c e r na b o u t t h e i m p a c t
o f r e g u l a t i o n o n f i r m s o f d i f f e re n t s iz es
. A l t h o u g h t h ep r e c e d i n g m e t h o d o l o g y is b
a s e d o n p l a n t r a t h e r t h a n f i r m - l e v e l d a t
a , itc a n e a s il y b e a d o p t e d f o r th e l a t t e r p u
r p o s e , s i m p l y b y a g g r e g a t i n gp l a n t s i n t
o t h e ir p a r e n t f i rm s . F i r m - l e v e l c o s t a n d
n e t r e v e n u e d a t a w i l lt h e n r e v ea l t h e d i s t
r i b u t i o n a l i m p a c t o f r e g u l a t i o n o n f i r m
s iz e. I n f a ct ,r e l i a n c e o n t h e m i c r o a n a l y t
i c a l a p p r o a c h s u g g e s t e d h e r e a l l o w s f a
ir l ye as y r e a g g r e g a t io n a l o n g v i r tu a l ly a n
y d i m e n s i o n d e e m e d r e le v a n t fo rp o l i c y - m
a k i n g p u r p o s e s ( p r o v i d i n g t h e n e ce s s ar y
d a t a i s a v a i la b l e ).T h u s , i t is p o s s i b l e t o
c a p t u r e t h e e f fe c ts o f s c a le e c o n o m i e s , a
g e o fp l a n t , t e c h n o l o g y , et c.I t i s i m p o r t a
n t t o r e c o g n i z e , h o w e v e r , t h a t g i v e n s u f
f i c i e n t l yd e t a il e d m i c r o d a t a , t h is r e a g
g r e g a t i o n c a p a b i l i t y c a n be a b u s e d . F o re
x a m p l e , t h e re i s n o c o n c e p t u a l b a r r i e r t
o r e a g g r e g a t i n g f a c i li t i e s b yt h e p o l i t i
c a l p a r t y o f t h e o w n e r , c o n t r i b u t i o n s t o
p o l i t i c a l c a m p a i g n s ,e t c . T h i s i s n o t t o
s u g g e s t t h a t s u c h p o l i t i c a l a b u s e i s l i k
e l y , b u t o n l yt h a t i t is p o s s ib l e . T o i n s u r
e a g a i n s t i t s o c c u r r e n c e , th e m e t h o d s w ep
r o p o s e m u s t c ar ry with t h e m t h e s tr i c te s t s a
f e g u a r d s . P e r h a p s t h e b e s tc o n t r o l i s t o
r e l y o n r e p r e s e n t a t i v e d a t a , r e s i s t i n g
t h e t e m p t a t i o n t oc o l l e c t l a r g e v o l u m e s
o f c o n f i d e n t i a l , p l a n t - s p e c i f i c i n f o r
m a t i o n .I t is a l s o i m p o r t a n t t o r e c o g n i z e
th f it th e r i g o r s o f e n f o r c e m e n to f t e n v a r y
b y s iz e o f f i r m , w i t h c o n s e q u e n t d i s t r i b
u t i o n a l e f f e ct s. I nf ac t, re a l w o r l d i s s u e s
o f e n f o r c e m e n t p l a y a m a j o r r o l e i n d e t e r
m i n i n ga l l o f r e g u l a t i o n ' s c o s ts a n d b e n e
f i ts . W e s tr e ss t h e m h e r e o n l y b e c a u s e
t h e m o r e r e f i n e d t h e l ev e l o f d i s a g g r e g
a t i o n , t h e m o r e s e n s i t iv e a r e t h er es u lt s t
o u n d e r l y i n g e n f o r c e m e n t a s s u m p t i o n s
.R e g i o n a l I m p a c t s . J u s t a s m i c r o d a t a c a
n b e r e a g g r e g a t e d by f i r mc h a r a c t e ri s t ic s
, p l a n t - l e v e l d a t a c a n a ls o b e a g g r e g a t e
d b y g e o g r a p h i ca re a t o d e t e r m i n e t h e d i s t
r i b u t i o n a l e ff ec ts o f r e g u l a t i o n o n v a r i
o u sp a rt s o f t he c o u n tr y . T h e s a m e t e c h n i q u
e s a p p l i e d to c o m p u t i n gi m p a c t s b y s i z e o f
f i r m , a s w e l l a s t h e u s u a l c a v e a t s , a p p l y
h e r e .R e d i s t r i b u t i o n Is ' suesT h e n e t re v e n
u e m e a s u r e o f i m p a c t c a n a l s o b e u se d t o d e
t e r m i n e t h er e d i s tr i b u t i o n o f e c o n o m i c r
e so u rc e s a m o n g p r o d u c e r s a n d c o n s u m e r st
h a t r e s u l ts f r o m r e g u l a t i o n . A n e g a t i v e
n e t r e v e n u e ef f ec t ( d u e t o l o wc o m p l i a n c e
c os ts a t t h e in d u s t r y ' s r e le v a n t m a r g i n ) i
m p l i e s t h a t s o m eo f t h e c o st s o f r e g u l a t o r
y c o m p l i a n c e c o m e o u t o f t h e s u r p l u s , o r q
u a s i -r e nt s, p r e v i o u s l y a c c r u i n g t o p r o d
u c e r s , w h i l e a p o s i t i v e n e t r e v e n u ee ff ec
t i m p l i e s t h a t s o m e o f t h e c os ts o f r e g u l a t
o r y c o m p l i a n c e c o m e o u to f th e s u r p l u s p r e
v i o u s l y a c c r u i n g t o c o n s u m e r s .T h i s n e t
r e v e n u e e f fe c t is m e r e l y a c o m p a r a t i v e s t
a ti cc a l cu l a ti o n . O v e r t im e , b o t h s u p p l y a
n d d e m a n d c u rv e s s h i ft w i t hi n v e s tm e n t , t e
c h n o l o g i c a l c h a n g e , r i s in g i n c o m e s , a n
d c h a n g i n gp r ef e re n c es . I t is q u i t e l i k e l y
~ i n d e e d , i t is t o b e e x p e c t e d - - t h a t t h e n
e t
E I A R E V I E W 2 /1 5 3
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7/30/2019 Regulatory Cost
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r e v e n u e e f fe c ts o f r e g u l a t i o n w i l l c h a
f ig e o v e r t im e . T h i s v a r i a b i l it yw i l l re fl
ec t c h a n g e s i n n a t i o n a l e c o n o m i c c o n d i t
i o n s , c h a n g e s i ni n t e r n a t i o n a l m a r k e t c
o n d i t i o n s , i n v e s t m e n t cy c le s, d e m o g r a p
h i cs h if ts , a n d t e c h n o l o g i c a l c h a n g e . T h
u s , j u s t a s r e g u l a t i o n is l ik e l y t ol ea d t o r
e d is t r ib u t i o n a m o n g d i ff e r e n t p r o d u c e r
s a n d b e t w e e np r o d u c e r s a n d c o n s u m e r s , i
t is a ls o l i k e l y to le a d t o r e d i s t r i b u t i o nb
e t w e e n c o n s u m e r s a n d p r o d u c e r s i n d i f f e
r e n t t i m e p e r i o d s .I t is c o n c e p t u a l l y f e a
s ib l e, a l t h o u g h e x t r e m e l y d i f f i c u l t i np
r a c ti c e , t o i d e n t if y t h e t i m e p a t h o f p r i c
e a n d q u a n t i t y s h if ts d u e t or e g u l a t i o n . B
y d i s c o u n t i n g t h e n e t r e v e n u e d i f fe r e n t
ia l s t h a t r e s u lt o v e rt i m e , i t i s t h e n p o s s
i b l e t o d e t e r m i n e t h e e x t e n t o f i n t e r g e n
e r a t i o n a lr e d i s tr i b u t i o n o f w e a l t h b e tw
e e n p r o d u c e r s a n d c o n s u m e r s .T h e e s t i m a
t i o n o f t he s e d y n a m i c a d j u s t m e n t p a t h s is
l i k e ly to b ee x t re m e l y d if f ic u l t b e c a u se i n
f o r m a t i o n o n c h a n g e s i n b o t h d e m a n da n d s
u p p l y a r e r e q u i r e d . T h e s u p p l y s i d e i ss u
e s te n d t o b e p a r t i c u l a r l yc o m p l e x , s i n c e
t h e r e a r e f r i c t i o n a l c o s t s i n a d a p t i n g s
u p p l y t o n e wc o n d i t io n s , b e h a v i o r a l p h e n
o m e n a t h a t c o n d i t i o n n e a r - t e r m in v e s t o
rr e s po n s e , i m p e r f e c t io n s i n c a p i t a l m a r
k e ts , a n d o t h e r i m p e d i m e n t s t oc h a n g e t h a
t i n h i b i t t h e a d a p t a t i o n o f l o n g - l i v e d p
h y s i c a l c a p i t a l.S T R A T E G I C I N D U S T R I A L I
M P A C T ST h e p r e c e d i n g a n a l ys i s h a s v i e w e d
r e g u l a t o r y im p a c t s i n a ne s ta b l is h e d i n d u
s t r i a l e n v i r o n m e n t . W e n o w e x p a n d t h e d i
s c u s s io n t oi n c l u d e f u n d a m e n t a l s t r u c t u
r a l c h a n g e i n i n d u s t r ia l s i t u a ti o n s ,p r e
c i p i t a t e d o r c o n t r i b u t e d t o by r e g u l a t 0
r y . a c t i o n . T h e s e s tr uc tu ra ]~c h a n g e s , w e a
r g u e , a r e t h e r e s u l t o f s t ra t e g ic d e c i s i o
n s b y c o r p o r a t ed e c i s i o n m a k e r s .C o n s i d e
r , f ir s t, i s su e s o f o r g a n i z a t i o n a l s t r a t
e g y . M o s t s t r a te g i cc o r p o r a t e d e c i s i o n s
u l t i m a t e l y r e s t o n a s i m p l e p r o p o s i t i o n
, i .e ., t h a tn o s i n g l e o r g a n i z a t i o n c a n d o
a l l t h i n g s w e ll . T h u s , m a n a g e m e n t s ,t h r o
u g h o r g a n i z a t i o n a l d e s ig n , p l a n n i n g s y
s te m s , a n d c o n t r o lm e c h a n i s m s , a t t e m p t t
o f o c u s a n o r g a n i z a t i o n ' s l i m i t e d s k il ls
o nc e r t a i n p r o d u c t s , t e c h n o l o g i e s , a n d
c o n s u m e r s . I n t h e s h o r t r u n , t h ei m p o s i t
i o n o f u n f a m i l i a r r e g u l a t i o n s i s l i k e ly
to b l u r t h e e x i s t i n g f o c u so f m a n y o r g a n i z
a t i o n s . O v e r t i m e , a s re g u l a t i o n b e c o m e
s a p e r m a n e n ta n d f i n a n c i a l l y m o r e i m p o r
t a n t f a c t o r i n c o r p o r a t e d e c i s i o n s , w ew
o u l d e x p e c t o r g a n i z a t i o n a l l e a r n i n g a n
d a d a p t a t i o n t o t a k e p l a c e .T h e s e a d a p t a
t i o n s w o u l d u n d o u b t e d l y r e du c e re g u l a to
r y c o m p l i a n c ec os ts . O u r p r e s e n t u n d e r s t
a n d i n g o f th e se o r g a n i z a t i o n a l p h e n o m e n
a ,h o w e v e r , i s s u f f i c i e n t l y l i m i t e d a s t
o r e p re s .e n t a v i r t u a l " w i l d c a r d " i nt h e c
u r r e n t d i s c u s s i o n .R e g u l a t i o n s a l s o a ff
e ct m a r k e t i n g s t ra t e gy . A fi r m ' s c h o i c e o
fp r o d u c t s t o p r o d u c e - - a n d p a r t ic u l a r ly
, t h e b r e a d t h o f its p r o d u c tl i n e - - c a n m a t
e r i a l l y i n f l u e n c e t h e c o s t s o f c o m p l y i n
g w i t h ap a r t i c u l a r re g u l a t i o n . F o r e x a m p
l e , a c h e m i c a l m a n u f a c t u r e r w i t h ab r o a d
p r o d u c t l i n e m a y h a v e m o r e o p p o r t u n i t i e
s t o e c o n o m i c a l l yr e c o v e r a i r b o r n e d i s c
h a r g e s t h a n o n e w i t h a n a r r o w p r o d u c t l in
e .C o n v e rs e ly , a f i rm w i t h a n a r r o w p r o d u c t
l i n e m a y e x p e r i e n c e
5 4 E I A R EV I EW 2 /1
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e c o n o m i e s o f s ca le i n s u c h r e co v e ry n o t p
o s s i b le t o a p r o d u c e r o f ab r o a d e r l i n e .R a
t h e r t h a n a s s u m i n g t h a t e ff ec ts o f th i s k i n
d a re o f f s e tt i n g a n di g n o r i n g t h e m i n t h e a
n a l y s is , i t is b et te r to r e g a r d a d a p t a t i o n
s o fm a r k e t s t r a t e g ie s a s l ik e l y i n t h e f ac e
o f r e g u l a t o r y i n i t i a t i v e s a n dw o r t h y o f
i n v e s t i g a t i o n . W h i l e t h es e a d a p t a t i o n
s a r e e x t r e m e l yd i f f ic u l t t o p r e d ic t , t h e
y o f t e n h a ve m a j o r c o m p e t i t i v e i m p l i c a t
i o n s .O n b a l a n ce , t h e y g e n e r a l l y r e s u l t i
n r e d u c e d c o m p l i a n c e c o s ts as f i r m sr e p o s
i t i o n t h e m s e l v e s f o r c o m p e t i t i v e a d v a n
t a g e .I n a d d i t i o n to c h o o s i n g w h i c h p r o d u
c t s t o p r o d u c e , a f i r m m u s td e c id e h o w to p r
o d u c e t h e m . S t r at e gi c p r o d u c t i o n c h o ic e
s p r i m a r i l yi n v o l v e d e ci s i o n s a b o u t t h e d
e g re e o f ve r ti ca l i n t e g r a t i o n a n d t h ea m o u
n t a n d t y pe of c a p a c i ty to e m p l o y .I n t e g r a t
i o n d e c i s i o n s r e la t e t o a f i r m ' s s p a n o f p
r o d u c t i o nc o n t r o l . J u s t a s w e w o u l d e x p e
c t r e g u l a t o r y a c ti o n s t o i n f l u e n c es t ra t
eg i c d e ci s i o n s r e g a r d i n g t h e b r e a d t h o f p
r o d u c t l in e , w e w o u l da l s o e x p e c t t h e m t o i
n f l u e n c e t h e s p a n o f p r o d u c t i o n c o n t r o l
. A g a i n ,f i r m s a r e l i k el y t o r e p o s i t i o n t h
e m s e l v e s f or c o m p e t i t i v e a d v a n t a g e b ys e
e k i n g w a y s t o r e d u c e c o m p l i a n c e c o s t s t h
r o u g h a l t e r a t i o n s i n t h e i rd e g r e e o f v e rt
ic a l i n t e g r a t i o n . O n e e x a m p l e w o u l d b e a
m a n u f a c t u r e rw h o i n t e g ra t e s b a c k w a r d i n
t o t h e c o g e n e r a t i o n o f e l ec t ri c it y to l o w e
rc o st s, t o r e d u c e g r o ss e m i s s i o n s , a n d t o m
a i n t a i n a n e n e r g y s u p p l y 3 ~C a p a c i t y d e c
i s io n s a r e ev e n m o r e c o m p l i c a t e d . A f i r m '
sd e c is i o ns c o n c e r n i n g i t s c a p a c i ty n e e ds
o b v i o u s l y d e p e n d u p o nm a n a g e m e n t ' s e x p
e c t a t i o n s o f th e l ik e l y p r o f i t a b i l i ty o f
c a p a c i tyi n v e s t m e n t s . C h a n g e s i n r e g u l a
t i o n s , o f c o u r s e, o f t e n m a t e r i a l l yC h a n g
e e x p e c t a t i o n s i n t h i s ar e a .T h e r e l e v a n c
e o f t h e s e i s s u e s t o d e c i s i o n s r e g a r d i n g
newc a p ac i ty is g en e r a l l y r e co g n iz e d , a h h o u
g h t h e m e c h a n i s m b y w h i c ht h e s e e f f e c t s o
c c u r i s o f t e n m i s u n d e r s t o o d . P e r h a p s t h
e c r i t i c a l i s s u er e g a r d i n g n e w c a p a c i t y
i s i ts c o s t r e l a ti v e t o e x i s t i n g c a p a c it y
. W h e nn e w c a p a c i t y is l o w c o s t, st r a te g i e s
o f a g g r e s s i v e c a p a c i t y i n v e s t m e n t i n .l
a r g e- s c a le f a c il i ti e s, o f t e n i n g r o w i n g a
r e a s a n d u s i n g t h e l a te s tc a p i ta l - i n t en s i
v e t e c h n o l o g y , ar e c o m m o n . W h e n n e w c a p a
c it y is h i g hc o s t r e l a t i v e t o o l d c a p a c i t y
, s m a l l e r s c a l e f a c i l i t i e s , b u i l t m o r eh
e s i t an t l y , o f t e n i n o l d e r a re a s a n d u s i n g
h i g h v a r i ab l e c os tt e c h n o l o g i e s , b e c o m e
a t tr a ct iv e . T h e s e g e n e r a l p r o p o s i t i o n s
a res u m m a r i ze d in T a b l e 2 YF o r p u r p o s e s o f r
e g u l a t o r y i m p a c t a n a l y si s , c o n s i d e r t h
e c as e i nw h i c h n e w c a p a c i ty i s s ig n i f i c a n t
l y d i s a d v a n t a g e d b y t h e s t r i n g e n tN e w S o
u r c e P e r f o r m a n c e S t a n d a r d s ( N S P S ) . T a b
l e 2 i n d i c a te s t h a tw h e n n e w f a c il i ti e s ar e
h i g h c o s t t h e r e w i l l b e a t e n d e n c y to b u i l
ds m a l l - s c a l e f a c il i ti e s e v e n i f t h e y a r e
o f h i g h e r c o s t t h a n l a r g e r f a c i li ti e st h a
t r e a l i z e s i g n i f i c a n t s c a l e e c o n o m i e s .
B e c a u s e t h e h i g h e r c o s t s o fp r o d u c t i o n o
f t h e s e s m a l l e r f ac il it ie s a re s u s t a i n a b l
e f o r s o m e t i m e , t h i sm a y l e a d t o a m a j o r s ac
ri fi ce in l o n g - r u n p r o d u c t i v i t y . T o t h e e x
t e n tt h a t n e w t e c h n o l o g i e s ar e e m b o d i e d i
n c a p i ta l i n v e s t m e n t , t h is c o u l df u r t h e r
s l o w p r o d u c t i v i t y a d v a n c e s .
E I A R E V I E W 2 / 1 5 5
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T a b l e 2 a ls o s u g g e s ts a n i n c e n t i v e t o r e
n o v a t e e x i s t in g f a c i li ti e s,s i n c e n e w f a c
i l it i e s a r e c o m p a r a t i v e l y c o s t l y . If s u c
h f a c i l it i e s a r e a l s ot h e b e ne f ic i ar ie s of "
g r a n d f a t h e r " e x e m p t i o n s to s t r i n g e n t p
o l l u t i o nc o n t r o l s t a n d a r d s , s t r a t e g ic a
d a p t a t i o n s o f th i s so r t c o u l d f u r t h e r s l o
wt h e a t t a i n m e n t o f r e g u l a t o r y o b j e c t i v
e s .
T A B L E 2 T E N D E N C I E S I N C A P A C IT Y S T R A T E G
YW h e n n e w c a p a c i t y is r e l a ti v e l yl o w - c o s t
c a p a c i t y , t h e r e w i l l b e at e n d e n c y t o :1 . B
u i l d l a r g e r s c a l e2 . B u i l d " g r e e n f i e l d "
p l a n t s3 . L e a d d e m a n d g r o w t h w i t hp r e e m p t
i v e c a p a c i t y a d d i t i o n s4 . E x p l o i t e c o n o
m i e s o f s c a le a n dc o m p e t e o n t h e b a s i s o f p r
i c e5 . L o c a t e i n g r o w i n g a r e a s a n dle ss d e v e
l o p e d c o u n t r i e s6 . E x p l o i t o p e r a t i n g l e
v e ra g e b yc h o o s i n g c a p i ta l i n t e n s i v et e c h
n o l o g i e s7 . D e b t f i n a n c e n e w f a c i l it i e s
toe x p l o i t t h e i r f a v o r a b l e r i s kp r o f i l e
s8. F o r e c a s t d e m a n d u s i n gr e l a t i v e l y s i m
p l e t r e n dp r o j e c t i o n m e t h o d s9. E x p a n d b y
b u i l d i n g n e wc a p a c i t y
W h e n n e w c a p a c i t y is r e l a ti v e lyh i g h - c o
s t c a p a c i t y , t h e r e w i l l b e at e n d e n c y t o:1
. B u i l d s ma l l s ca l e2 . R e n o v a t e e x i s t i n g f
a c i l i t i e s3. M a k e m o r e f r e q u e n t c a p a c i t
ya d d i t i o n s t o b e t t e r t r a c k o r e v e nl a g d e m
a n d4 . A v o i d t h e r i s k a s s o c i a t e d w i t ht h e e
x p l o i ta t i o n o f e c o n o m i e so f s c a le a n d c o m
p e t e o n t h eb a s i s o f s e r v i c e , q u a l i t y , a n
do t h e r d i m e n s i o n s5 . L o c a t e i n d e v e l o p e d
a re a s w i t he x i s t i n g m a r k e t s6. A v o i~ t o p e r
a t i n g r i s k b yc h o o s i n g t e c h n o l o g i e s w i t
h ah i g h r a t i o o f v a r i a b l e t o t o t a lcos t s7 . D
e b t f i n a n c e e x i s t i n g f a c i l i t i e st o e x p l
o i t t h e i r f a v o r a b l eu t i l i z a t i o n e x p e c t
a t i o n s8. F o r e c a s t d e m a n d u s i n gs o p h i s t i
c a t e d e c o n o m e t r i c
m e t h o d s9. E x p a n d b y a c q u i s i t i o n o fe x i s
t i n g c a p a c i t y
T h e r e w i l l b e le s s o f a t e n d e n c y t o b u i l d
c a p a c i t y a h e a d o fd e m a n d w h e n n e w c a p a c i
ty i s h i g h c os t. I n t he s e c i r c u m s t a n c e s , a
ni n d u s t r y ' s s u p p l y c u r v e w i l l b e r e l a ti v
e l y in e l a s t ic i n t h e f ac e o f
5 6 E I A R EV I EW 2 /1
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d e m a n d c h a n g e s . T h i s , i n t u r n , h a s p r i
c e i m p l i c a t i o n s t h a t c a n s h if tt h e d i s t r i
b u t i o n a l b u r d e n o f r e g u l a t i o n ' s c o s t s f
r o m c o n s u m e r s t op r o d u c e r s a n d b a c k a g a i
n w i t h s w i n g s i n t h e b u s i n e s s c y c le . F i n a
l l y ,t h e c a p a c i t y p r e s s u r e s o n e x i s t i n g
f a c i l i t i e s m a y w e l l c o m p e l t h e s ef a c il it
ie s t o o p e r a t e a t h i g h e r t h a n o p t i m u m c a p
a c i t y u t i l iz a t i o n r a te s ,f u r t h e r s a c r if
ic i n g p ro d u c t i v i t y o n t he m a r g i n .S i n c e d e
b t f i n a n c i n g o f n e w i n v e s t m e n t w i l l b e l
es s a t t ra c t i v e t ot h e r e la t i v e ly h i g h r is k n
e w f a c i li ti e s, r e a l i n v e s t m e n t i n a n i n d u
s t r ym a y b e c o m e r e la t iv e l y i n s en s i ti v e to m
o n e t a r y p o l ic y . W h e n c o u p l e dw i t h i n e l a s
ti c s h o r t - r u n s u p p l y , t h e r e s u l t c o u l d b
e a n i n d u s t r yr e l a t i v e l y i n s e n s i t i v e t o
m a c r o e c o n o m i c p o l i c y a c t i o n s .N o t e , h o
w e v e r , t h a t f o r a ll t h e s tr a t e g ic u n c e r t a
i n t y , c h a n g e s i nt h e r e la t iv e c o s t o f n e w v
e r su s e x i s t i n g c a p a c i t y a r e t h e p r i m a r y
f a c to r sa f f e c t in g f i r m d e c i s i o n m a k i n g i
n t h es e a r ea s . A c os t s t u d y , e v e n if i tc a n n o
t c a p t u r e o r f o re c a s t th e s tr a t e g ic im p l i c
a t i o n s o f r e g u l a t o r ya c t io n , c a n d e t e r m i
n e w h e t h e r n e w c a p a c i t y is re l a ti v el y h i g h
o r l ow "c o st . T h i s i n f o r m a t i o n , i n a n d o f i
ts e lf , h a s c o n s i d e r a b l e v a l u e t op o l i c y m
a k e r s , a n d s h o u l d b e c o l le c t e d w h e n e v e r
p o s s ib l e .F o r e x a m p l e , r e g u l a t i o n s t h a t
a p p l y u n i f o r m l y t o o l d a n d n e wf a c i l i t i e
s t e n d , o n b a l a n c e , t o f a v o r n e w i n v e s t m e
n t , s i n c e r e t r o f i t t i n go l d p l a n t s g e n e r
a l l y t e n d s t o b e m o r e c o s t l y t h a n a t t a i n i
n g a g i v e ne m i s s i o n s l e ve l i n a n e w p l a n t . I
n c o n t r a s t, t h e s t r i n g e n t N e w S o u r c eP e r f
o r m a n c e S t a n d a r d s m a y i n c r e a s e t h e c o st
o f n e w f a c il it ie s re l a ti v et o e x i s t i n g o n e s
. S i n c e c a p i t a l c 0 s ts t o d a y a r e w e l l a b o v
e t h e h i s t o r i cl ev e l s r e f l ec t ed i n t h e cost s
t r u c t u r e s o f e x i s t i n g f a c i l i t i e s , c a p i
t a l -i n t e n s i v e c o m p l i a n c e o p t i o n s a r e l
i k e ly to b e c o m e f i n a n c i a l l y le ssa t t r ac t i v
e .I n s u m m a r y , c r i t ic a l s t r a te g i c d e c i s i
o n s r e g a r d i n g t h e s c a l e ,l o c a t i o n , t i m i
n g , a n d t e c h n o l o g i c a l c o n f i g u r a t i o n o f
n e w f a c i l it ie s a r ei n f l u e n c e d b y r e g u l a t
i o n , d e p e n d i n g o n t h e e ff ec t o f c o m p l i a n c
e c o st so n t h e re l a ti v e c o m p e t i t i v e p o s i t i
o n o f n e w a n d o l d f a c i li ti e s.T h i s o b s e r v a t
i o n i s r e l e v a n t t o th e c u r r e n t d i s c u s s i o
n b e c a u s em a n a g e m e n t w i l l n o t s i m p l y c o m
p l y w i t h a g i v e n r e g u l a t i o n o r c l o s e af a c
i l i t y - - th e t w o ch o ic e s c o m m o n l y e n v i s i o
n e d - - b u t r a t h e r W illo f t e n t a k e t h e o p p o r
t u n i t y t o ra t i o n a l i z e i ts e x i s t i n g c a p i t
a l s t o ck t o f itc u r r e n t a n d f u t u re n e e ds . S o
m e e q u i p m e n t w i l l p r o b a b l y be r e tr o fi tt e
dto c o m p l y w i th n e w s ta n d a rd s a n d s o m e o u t m
o d e d m a c h i n e r y m a y b er e ti r ed , b u t i n a d d i
t i o n , n e w p r o d u c t s a r e l ik e l y , t o b e e m p h
a s i z e d ,e x i s t i n g p r o d u c t i o n p r o ce s se s re
o r g a n i z e d , a n d manage ment a t t en t ionr e d ir e c te
d . T h e f a ct t h a t t h is r a t i o n a l i z a t i o n w i l
l o c c u r a t everyf a c i l i t y - - n e w o r o l d - - s u g
g e s ts t h a t t h e t r u e e ff ec ts o f r e g u l a t i o n o
ne x i s t i n g c a p a c i t y g o w e l l b e y o n d t h e i m
p a c t o n f a c i l it y c l o s i n g s .T h e a b o v e a n a l
y s i s f u r t h e r s u g g e s ts t h a t n o in d u s t r y c
os ta n a l y s i s is c o m p l e t e w i t h o u t a n e x p l i
c i t e x a m i n a t i o n o f t h e s t ra t e g i ci m p l i c a
t i o n s o f r e g u l a t o r y a c t i o n . W h i l e t h e se
s tr a te g i c d e c i s i o n s ar en o t l i m i t e d t o c a p
a c i t y e ff ec ts , a n e x a m i n a t i o n o f s u c h e f fe
c ts w i l l g o al o n g w a y t o w a r d a d d r e s s in g t h
e l i k e ly s tr u c t u ra l c h a n g e s r e g u l a t i o nc a
n b e e x p e c t e d t o p r o d u c e .
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![CAUSE OR CURE? COST-BENEFIT ANALYSIS AND REGULATORY GRIDLOCKNYU).pdf · LIVERMORE MACRO.DOC 11/17/2008 9:26:47 PM 2008] COST-BENEFIT ANALYSIS AND REGULATORY GRIDLOCK 109 The news](https://img.pdfslide.net/doc/110x75/5f7a65d2a4f7a943f7778fa3/cause-or-cure-cost-benefit-analysis-and-regulatory-gridlock-nyupdf-livermore.jpg)
