What you’ll learn to do: analyze the efficacy of government policies to lessen positive and negative externalities

Figure 1. In the late 1960s and early 1970s the United States started passing comprehensive environmental laws that can be described as Command-and-Control Regulation. The question that persists is: “How effective has this regulation been?

With an understanding of what exactly positive and negative externalities are, we can now examine how the government uses regulation and economic incentives to help markets produce more efficient outcomes.

Command-and-Control Regulation

When the United States started passing comprehensive environmental laws in the late 1960s and early 1970s, a typical law specified how much pollution could be emitted out of a smokestack or a drainpipe and imposed penalties if that limit was exceeded. Other laws required the installation of certain equipment—for example, on automobile tailpipes or on smokestacks—to reduce pollution. These types of laws, which specify allowable quantities of pollution and which also may detail which pollution-control technologies must be used, fall under the category of effluent standards. In effect, effluent standards require that firms increase their costs by installing anti-pollution equipment; firms are thus required to take the social costs of pollution into account.

Command-and-control regulations, such as effluent standards, have been highly successful in protecting and cleaning up the U.S. environment. In 1970, the Environmental Protection Agency (EPA) was created to oversee all environmental laws. In the same year, the Clean Air Act was enacted to address air pollution. Just two years later, in 1972, Congress passed and the president signed the far-reaching Clean Water Act. These command-and-control environmental laws, and their amendments and updates, have been largely responsible for America’s cleaner air and water in recent decades. However, economists have pointed out three difficulties with command-and-control environmental regulation.

First, command-and-control regulation offers no incentive to improve the quality of the environment beyond the standard set by a particular law. Once the command-and-control regulation has been satisfied, polluters have zero incentive to do better.

Second, command-and-control regulation is inflexible. It usually requires the same standard for all polluters, and often the same pollution-control technology as well. This means that command-and-control regulation draws no distinctions between firms that would find it easy and inexpensive to meet the pollution standard—or to reduce pollution even further—and firms that might find it difficult and costly to meet the standard. Firms have no reason to rethink their production methods in fundamental ways that might reduce pollution even more and at lower cost.

Third, command-and-control regulations are written by legislators and the EPA, and so they are subject to compromises in the political process. Existing firms often argue (and lobby) that stricter environmental standards should not apply to them, only to new firms that wish to start production. Consequently, real-world environmental laws are full of fine print, loopholes, and exceptions.

Although critics accept the goal of reducing pollution, they question whether command-and-control regulation is the best way to design policy tools for accomplishing that goal.