Friday, July 26, 2013

A Preview of Chapter Four of My New Amazon Kindle Book

Whether the price of my book is $0 or $2 tomorrow, you will still gain some consumer surplus if you buy my new "classic" Fundamentals of Environmental Economics.   In this post, I will talk about the book's chapter four titled; "Where Do Dirty Factories Locate"?

Erin Mansur and I recently published a paper on this topic in the Journal of Public Economics.  

My starting point is that many urban pollution externalities exist because dirty industrial activity takes place in a geographic location filled with people.   Why are the people living there? Why did the firm choose this location and why does it continue to produce there?   Unlike many undergraduate texts, I introduce the reader to a discrete choice problem namely does a polluting firm locate in Boston, San Francisco or Dallas?  This cost minimizing firm recognizes that these three possible locations differ with respect to local wages, local real estate prices, distance to final consumers and they differ with respect to their pollution regulation.  A firm will know its production needs. For example, a firm that needs a lot of land to produce may choose to avoid the place where land is expensive.  Alternatively, a firm that pollutes a lot may avoid the high regulation area.  I teach the reader how to calculate the total cost of production for a given firm in each possible location and we spot the cost minimizing choice.

I then walk the reader through  the "reverse engineering" problem of "given that a firm has chosen a specific location to produce, what must be its priorities for how it tradeoff various attributes of a city (i.e how important are low wages versus low  energy prices in determining whether the factory moves to a given city).  Why does this model matter? In this day and age when everyone is asking why Detroit is dying, why don't firms moves there?  A good model of firm locational choice is relevant for predicting which cities will grow and which cities will experience an influx of pollution from pollution intensive industries.  In joint work with my co-authors in China right now, we are using these same models to explore the migration of industrial activity from coastal cities to poorer western cities.

Returning to chapter 4 of my book, once I finish the domestic locational choice example --- I then turn to the threat of offshoring.  If the U.S EPA introduces stringent environmental regulation, what types of firms can credibly threaten to move abroad to a "pollution haven"?     So, U.S regulation can reduce U.S pollution by reducing pollution per unit of industrial activity (a technique effect) or by unintentionally displacing production to other nations.  The "Goldilocks" goal is to make regulation tight enough to achieve the former goal while not making too tight so that "we lose jobs".   How the U.S regulators navigate this potential mine field requires an ability to engage in fine tuning and to assess which jobs are the most "footloose".

At the end of the Chapter, I return to one of my favorite themes.  Deindustrialization in the U.S Rust Belt, in Eastern Europe and now in China's major coastal cities has dramatically improved local environmental quality.

The Chapter ends with a small model that Gary Becker would like.  It builds on his work with Ehrlich on Self Protection.

Industrial Environmental Negligence and Endogenous Effort by Firms

Consider an oil company that can take costly precautions that will reduce the probability of an oil spill. Such oil spills (when they occur) cause significant environmental damage.  I study how the expectation of a large monetary fine for an oil spill incentivizes the for profit company to take more ex-ante precaution (i.e invest more to minimize the probability of a spill).  So, credible punishment leads to good behavior!  All parents know this and I show how in a simple calculus example to solve for the optimal effort by the firm and how this effort is an increasing function of the ex-post expected fine that the company would have to pay if there is a spill.  

So, this chapter highlights several ways to reduce industrial pollution externalities using an economics approach.  Again, while this book is a textbook it also isn't a textbook --- anyone can read it and it will make you think! If you disagree, I will give you your $2 back!