Behind the Numbers: Polluted Data

In July, Carol Browner, chief of the Environmental Protection
Agency, issued new regulations reducing permissible levels of
smog and particulate (fine soot) pollution. The political battle
leading up to the decision was fierce, even within the administration.
One staff member on the Council of Economic Advisors maintained
that the regulations would cost a whopping $60 billion—a figure
quickly seized upon by industry opposition. The EPA's own cost
estimate was much more modest, between $6 billion and $8 billion.
In making her case for the new regulations, however, Browner publicly
disavowed even her own agency's cost estimates. She argued that
industry would find a way to do it cheaper.

Whom to believe? Confronted with conflicting estimates, most lay
people either throw up their hands or choose sides ideologically.
But history provides a basis for evaluating these estimates. Not
only do industry lobbyists wildly overestimate the costs of proposed
environmental regulations. More surprisingly, academic and government
economists consistently do too—and for an equally surprising reason.
When forecasting the costs of new environmental regulations, economic
analysts routinely ignore a primary economic lesson: Markets cut
costs through innovation. And innovation can be promoted through
regulation. This history is worth bearing in mind as we approach
the most important environmental controversy to date—how to deal
with the crisis of global warming.


THE ABCS OF OVERESTIMATION

In every case we have found where researchers have calculated
actual regulatory costs and then compared them to ex ante
estimates, the estimate exceeded the actual cost. We have uncovered
a dozen such efforts, ranging from A (asbestos) to V (vinyl chloride).
In all cases but one, the initial estimates were at least double
the actual costs.

Asbestos. When the Occupational Safety and Health Administration
(OSHA) instituted regulations covering exposure to asbestos in
the early 1970s, they hired a consulting firm to estimate the
cost of compliance. Two later studies found that the original
prediction for the cost of compliance was more than double the
actual cost, because of overly static assumptions.

Benzene. In the late 1970s, the chemical industry predicted
that controlling benzene emissions would cost $350,000 per plant.
Shortly after these predictions were made, however, the plants
developed a process that substituted other chemicals for benzene
and virtually eliminated control costs.

Chlorofluorocarbons (CFCs). In 1988, reducing CFC production
by 50 percent within 10 years was estimated by the EPA to cost
$3.55 per kilogram. By 1993, the goal had become much more ambitious:
complete elimination of CFC production, with the deadline moved
up two years, to 1996. Nevertheless, the estimated cost of compliance
fell more than 30 percent, to $2.45 per kilogram. And where substitutes
for certain CFCs had not been expected to be available for eight
or nine years, industry was able to identify and adopt substitutes
in as little as two years.



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CFCs in automobile air conditioners. In 1993 car manufacturers
estimated that the price of a new car would increase by $650 to
$1,200 due to new regulations limiting the use of CFCs. In 1997
the actual cost was estimated to be $40 to $400 per car.

Coke ovens. The original OSHA estimate for the cost of
complying with the 1976 coke oven standard was more than five
times higher than estimates of actual costs. OSHA's contractor
suggested that complying with the standard would cost from $200
million to more than $1 billion. However, a Council on Wage-Price
Stability study later estimated the actual cost of the standard
to be $160 million.

The OSHA consultant estimated that three steel firms in their
sample would spend $93 million on capital equipment and $34 million
in annual operating costs to comply with the regulations. A later
study by Arthur Andersen determined that the three firms actually
spent between $5 million and $7 million in 1977 to comply with
the standard, and only $1 million to $2 million on capital expenditures.
Ultimately, firms were able to meet the standard without incurring
all of the capital costs in the first year, and actual compliance
costs were dramatically lower than originally predicted.

In the late 1980s, coke production again came under regulatory
scrutiny, this time by the EPA. In 1987, the agency estimated
that the cost of controlling hazardous air pollution from coke
ovens would be roughly $4 billion. By 1991 that estimate fell
to between $250 million and $400 million.

Cotton dust. In 1976, OSHA proposed a maximum permissible
exposure limit of 0.2 milligrams per cubic meter for cotton dust,
and its consultant estimated that compliance costs would be approximately
$700 million per year. The standard promulgated in 1978 actually
allowed for higher exposure levels in some sectors of the textile
industry, but the small changes in the standard do not fully explain
the decrease in estimated compliance costs; in 1978 the estimate
fell to $205 million per year. Moreover, a new study conducted
in 1982, after the Reagan administration called for a review of
the standard, concluded that compliance costs were $83 million
per year.

Halons. In 1989 members of the United Nations Environment
Program's Halons Technical Options Committee disagreed on whether
direct halon replacements could be found and whether a phase-out
was possible. However, in 1993 the committee concluded that a
phase-out of halons, a substance found in fire extinguishers that
destroys the ozone layer faster than chlorofluorocarbons, would
be both technologically and economically feasible by 1994.

Strip mining. Prior to the passage of the 1978 Surface
Mining Control and Reclamation Act, estimates for compliance costs
ranged from $6 to $12 per ton of coal. Actual costs for eastern
coal operations have been in the range of 50 cents to $1 per ton.
After the regulations were adopted, the market switched away from
coal deposits with high reclamation costs. Ready substitutes included
surface-minable coal in flatter areas (with lower reclamation
costs), and underground deposits.

Vinyl chloride. OSHA's vinyl chloride standard, set in
1974, provides a final example of wildly excessive cost projections.
The agency's consultant estimated that it would cost $22 million
per year to meet the permissible exposure limit of 2 to 5 parts
per million (ppm) in the vinyl chloride monomer sector, and $87
million per year to meet the 10 to 15 ppm exposure limit in the
polyvinyl chloride sector. In addition, the consultant argued
that the 1 ppm permissible exposure limit simply could not be
attained. The president of Firestone's plastics division said
that a standard of 1 ppm "puts the vinyl plastics industry
on a collision course with economic disaster."

In spite of these protests, OSHA did adopt the strict permissible
exposure limit of 1 ppm. A study conducted several years later
by researchers from the Wharton School of Business estimated that
the total cost of compliance for both sectors had been
about $20 million per year. A 1976 congressional research paper
also indicated that the actual cost of compliance was dramatically
less than the original prediction. The early claims that the 1
ppm standard could not be met evaporated; instead, the regulatory
action led to about a 6 percent rise in polyvinyl chloride prices.

While costs have been consistently overestimated for emission
reduction, they have been underestimated for environmental cleanup.
For example, when the Clean Water Act was enacted in 1972, the
EPA estimated that $12.6 billion was needed to provide secondary
sewage treatment systems. According to the American Enterprise
Institute, actual spending for sewage treatment between 1972 and
1981 exceeded $160 billion.

Costs for the Superfund program have also mushroomed. When first
launched, people expected the mandated cleanups to apply to a
small handful of Love Canals. However, the program has expanded
dramatically, now covering far more than a thousand sites. In
addition, cleanup has proved far more costly than predicted: The
average cost overrun on cleanup expenditures at Superfund sites
has been 44 percent.

The message from these cases is clear. On the one hand, treating
already polluted water, cleaning dirty soil, and scrubbing oily
rocks costs a lot of money, (much) more than expected. On the
other, when it comes to reducing pollution emissions at the source,
it is almost certain to be (substantially) cheaper than we think
it will be. Updating Poor Richard's Almanack, an ounce
of prevention is clearly worth a pound of cleanup.

Why were the estimated costs of reducing emissions at the
source so inflated? The reason, of course, is "technology-forcing."
When industry is required to lower pollution output, it usually
doesn't just slap a new filter on an existing process; it often
invents new technology. Frequently the new technology turns out
to have higher productivity benefits, which help to offset the
cost of the regulation. To see this, it is worth looking in detail
at two high-profile cases where markets have responded to regulation
by cutting costs.


COKE BREAK

Robert Hahn, a well-known environmental economist, is currently
a resident scholar at the American Enterprise Institute and an
adjunct research fellow at Harvard's Kennedy School of Government,
and is a former senior staff member of Bush's Council of Economic
Advisors. In 1990 he and a co-author wrote a report for the U.S.
Business Roundtable predicting the impact of the proposed Clean
Air Act amendments on employment. These amendments had the dual
purpose of cleaning up both acid rain and so-called "air
toxics" from industrial plants.

The executive summary of Hahn's report leaves "no doubt that,
across the Clean Air Act Amendments studied, there are a minimum
of several hundred thousand jobs at various levels of severity
of risk—even with the more moderate [Bush] Administration proposals."
Hahn's absolute minimum prediction was 20,000 jobs directly lost,
mostly from the closing of coke ovens in the steel industry. Hahn
and his co-author viewed this as "truly a limiting, rock-bottom
estimate" for several reasons. Important among them was that
it considered only job losses arising from one portion of the
bill—control of air toxics.

The amendments did pass later in 1990. The bill was in most respects
more restrictive on air toxics than the one on which Hahn's study
based its minimum job loss estimates. The legislation also authorized
retraining funds of $50 million per year for displaced workers,
which gives a nice way to track job impacts.

In the almost seven years since passage of the legislation, fewer
than 7,000 workers have received aid because their jobs were affected
by the Clean Air Act amendments. And the vast majority of these
have been eastern, high-sulfur-coal miners, who have been laid
off due not to the air toxics provision, but to the acid rain
amendment. (The same legislation has in fact led to a boom in
the western, low-sulfur-coal industry.) No workers from shut-down
coke oven plants have received adjustment assistance. And between
1992 and 1995, production in the coke and (closely related) blast
furnace industries actually increased, from $1.74 billion to $1.95
billion.

Hahn was consulting for industry here, so it is not surprising
that his numbers were a bit on the high side. Corporate America,
when faced with new regulations, has never been shy about claiming
that the sky is falling. But Hahn is not a hired gun; he has very
solid academic credentials. How could he have gotten it so wrong?

It turns out that Hahn's overestimation of regulatory impacts,
while extreme, is not unusual. In fact, as we have seen in every
case for which we have been able to track down data, academic
and government economists have routinely overestimated the costs
of reducing pollution emissions—by at least 30 percent, and generally
by more than 100 percent.


THE ACID TEST

The EPA's acid rain program is another dramatic case in point.
Since 1995, electrical utilities have been required to hold permits
for each ton of sulfur dioxide they emit. These permits, in limited
supply, are distributed to firms each year by the government.
The innovative feature of the program is that the permits can
then be bought and sold. Given this, permit prices roughly reflect
per ton pollution control costs. This is true because a firm generally
wouldn't buy an extra permit if the cost of doing so exceeded
the cost of reducing sulfur emissions by a ton.

When the tradable permits market was being designed in the early
1990s, credible industry estimates of permit prices (and thus
control costs) were $1,500 per ton; the EPA was predicting $750.
In 1997, permits were in fact selling for around $100 a piece.

Part of the current low permit price is due to a higher than expected
initial supply of permits, but real compliance costs have in fact
been two to four times lower than the EPA expected, and four to
eight times below industry estimates.


THE VIRTUE OF MARKETS

When environmental economists figure their cost estimates, one
particular lapse is quite startling. Economists have tended to
grossly underestimate a virtue of markets they readily preach
elsewhere: flexibility. When pollution regulation makes a certain
type of production more expensive, markets adjust—in fairly rapid
order, uncovering substitute methods of production, and developing
cheaper cleanup technologies. This fact, while not completely
ignored by economists, is seldom factored into their cost estimates.
Instead analysts tend to predict future costs statically, as if
firms would continue to use existing practices and technologies.

So, for example, the much lower than expected costs for the acid
rain program can be explained in retrospect by the increased flexibility
that firms were given to achieve their mandated reductions in
sulfur dioxide emissions. Rather than install expensive scrubbers
(or buy extra permits), many more firms than expected have met
their sulfur dioxide targets by switching to low-sulfur coal,
or developing new fuel-blending techniques. Railroad deregulation,
along with economies of scale, led to an unexpected decline in
low-sulfur-coal prices. And with the increased competition from
coal, scrubber prices fell by half from 1990 to 1995.

All this is easy to see after the fact, but would have been very
hard to predict. Hahn got his 20,000 lost jobs from air toxics
regulation following this same practice—ignoring innovative market
responses. While parenthetically noting that "technological
improvements could reduce the direct economic impacts," the
study explicitly ignores the possibility "because of the
difficulties in predicting how technology will evolve." Because
in the mid- to late 1980s, available control technologies for
coke ovens seemed to be quite expensive, Hahn assumed that regulating
air toxics would simply shut down much of the industry.

However, as we saw above, the EPA's own estimates of control costs
for coke ovens were plummeting even as Hahn was writing his report.
By 1991, they were down by a factor of ten or more from the 1987
forecasts. Hahn may not have been aware of the EPA's work; instead
he cites an industry source to justify his claim that "there
is widespread agreement that coke ovens will be required to close
down, with an estimated loss of 15,000 jobs."

A secondary reason for the overestimates is that in implementation,
legislation is never as draconian as it appears on paper. In practice,
timetables get stretched out, compliance dates get extended, and
waivers are granted. Eventually the regulations begin to bite,
but industry is usually given a fair amount of time to adjust.
Most cost estimates assume high degrees of near-term compliance.

Peering into the future is hard work. It is, in fact, close
to impossible for economists to predict the specifics of how technology
will evolve. This is especially true since much of the information
about potential innovations consists of closely held trade secrets,
which industry has little incentive to reveal. But basing cost
predictions on scenarios that assume no technical evolution is
guaranteed to produce gross overestimates. Innovation is indeed
something at which markets are very good. When given a narrowly
defined task—to produce commodity x emitting less of pollutant
y
—short-term substitutions and long-term shifts in technology
guarantee large cost reductions over current practice.


INFLATING COSTS, IGNORING BENEFITS

In the late 1980s, when the international phase-out of ozone-destroying
CFCs got underway, a company called Nortel began looking for substitutes.
The company, which had used the chemicals as a cleaning agent,
invested $1 million to purchase and employ new hardware. Once
the redesigned system was in place, however, Nortel found that
it actually saved $4 million in chemical waste-disposal costs
and CFC purchases.

The CFC regulatory compliance costs for Nortel clearly were $1
million. But how do we figure in the $4 million savings? Economists
have long recognized that a dollar spent on environmental pollution
control is not the "true" cost to society. Some have
argued that the cost is in fact much higher, because environmental
spending "diverts" capital investment from more productive
uses.

In recent years, by contrast, Michael Porter of the Harvard Business
School has been pointing to examples like Nortel to argue that
environmental regulations, by forcing firms to rethink their production
processes, can often lead to lower production costs and lend a
competitive advantage.

More generally, much of the reported costs of environmental regulation
occurs when firms invest in new capital equipment, thoroughly
redesigned to be both cleaner and more productive. Many of these
investments would have happened sooner or later anyway. So a primary
effect of regulation is to speed up the investment process. This
is costly to firms, since they must scrap old machinery that is
not necessarily worn out. When this happens, however, much of
measured compliance cost is in fact just early capital investments.
This in turn implies that the compliance figures are much higher
than the real costs.

Researchers at Resources for the Future recently conducted a study
asking how much $1 spent on environmental protection really costs
an industry. For some industries, specifically steel, the answer
was little more than $1, due to the diversion effect. For others,
notably plastics, the industry actually saved money as productivity
was boosted. On average, the study concluded, $1 spent on environmental
pollution control reflected a real expense of 13 cents. In general
then, even when cost estimates are "correct," this new
research suggest that the reported values often overstate the
true costs to the firm, on average by a factor of seven.


THE ROAD TO KYOTO

The debate over compliance costs is now heating up for the mother
of all pollution issues—global warming. International negotiators
are at work on what are supposed to be binding carbon emission
reduction requirements, to be announced in Kyoto in December.
The European Union is pushing for a 15 percent cut below 1990
levels to be achieved by 2010; the members of the Alliance of
Small Island States—whose very existence is at stake due to anticipated
flooding—want a 20 percent cutback by 2005.

The United States, by far the world's biggest greenhouse polluter,
is dragging its heels. President Clinton, when pressed to commit
the U.S. to specifics, has promised only to convene a conference
in the fall to try to achieve a consensus among American industry,
labor, and other groups on the need for action. And Clinton will
clearly face a tough sales job for ratification in the Republican-controlled
Senate.

Academic economists have lined up behind a strong U.S. leadership
role in Kyoto. Greenhouse "moderates" like Yale's William
Nordhaus and Harvard's Dale Jorgenson headed up a list of more
than 2,000 economists who signed a letter arguing that a first
round of carbon emission reductions could be achieved at relatively
low cost. And in late July, to the dismay of U.S. industry, the
Clinton economic team published its official cost estimates, confirming
this general view.

There is a minority opinion among economists that reducing greenhouse
gas emissions will be very, very cheap, and in the long run, even
profitable. The reasons? Already existing energy efficiency technologies
can help the United States break its addiction to cheap oil without
too much pain. And within a decade or two, renewable fuel sources—coupled
with efficiently redesigned technologies—will be cheaper than
oil or coal are today. In this view, the sooner we redirect the
market into a serious search for alternatives to fossil fuels,
the richer we will be in the future.

There are, however, likely to be transitional costs, both for
workers, particularly in fossil fuel industries, and for Third
World countries. In the past, government has not done a very good
job in equitably sharing the burdens of such transitions. This
is no reason to reject a global warming accord, but it is a strong
reason to be alert to the allocation of costs and benefits.

In the global warming debate, as when past environmental regulations
have been proposed, there are the three compliance cost scenarios:
apocalyptic (industry), doable but costly (academic and government),
and profitable (a few visionaries). Our guess, based on the record
of previous academic and government cost forecasts, is somewhere
between doable and profitable.



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