CHAPTER 10

Chapter 10: Decentralized Policies: Liability Law, Property Rights, Voluntary Action

Overview

• Title: One of the Deadliest Cover-Ups in American History

Liability Law

• Definition: Liability laws make polluters liable for damages they cause.

• Key Economic Effects:

  • Converts external damages into private costs.

  • Encourages firms to consider environmental harm in decision-making (not just post-fact compensation).

  • When polluters are liable for damages, they incorporate these costs into their cost calculations.

Liability and Incentives

• Relation between Damages and Costs:

  • If damages must be fully compensated, firms can reduce costs by reducing damages.

  • Firms will reduce emissions as long as:

  • ext{MAC} < ext{MD}

  • Emissions stop when:

  • $ext{MAC} = ext{MD}$ (efficient level $e^*$).

• Theoretical Implication:

  • Liability can theoretically achieve efficiency without requiring a central emissions standard.

Effectiveness of Liability Law

• Works Well When:

  • Harm is observable.

  • Causation can be proven.

  • Damages equal true marginal harm.

  • Firms expect to actually pay damages.

Case Study: Dark Waters - Real Case Background

• DuPont's Use of PFOA:

  • Used perfluorooctanoic acid (C8) to produce Teflon, a persistent "forever chemical."

  • Contaminated drinking water in West Virginia.

  • Internal documents suggested early knowledge of risk associated with PFOA.

• Health Impacts:

  • Proving health impacts took years of scientific study.

  • Nearly 20 years of litigation before significant settlements were reached.

Health Risk Analysis: Dark Waters TPS

• Kidney Cancer Risk Statistics:

  • Baseline lifetime kidney cancer risk = 2%.

  • Exposed lifetime risk = 3.5%.

  • Increase = 1.5 percentage points.

• Impact on 100 Exposed Individuals:

  • Of 100 individuals exposed to PFOA:

  • 2 would develop kidney cancer anyway.

  • 3.5 would develop it.

  • 1.5 excess cases attributable to exposure.

Causation in Liability Law

• Challenges of Establishing Liability:

  • Individual causation must be proven, which is difficult due to the following factors:

  • Environmental harm is often probabilistic (increased probability of disease, not certainty).

  • Harm is frequently delayed and diffuse.

  • Scientific uncertainty complicates establishing clear links between exposure and health outcomes.

• Identifying Excess Cases:

  • While excess cases can be identified in a population, determining which individuals are affected is not feasible.

Deterrence and Liability

• Conditions for Efficient Liability:

  • For liability to equate $ext{MAC} = ext{MD}$, firms must expect:

  • Harm will be detected.

  • Causation can be proven.

  • Damages will be imposed.

  • Enforcement will occur with high probability.

Expected Penalty Calculation

• Formula:

  • $ext{Expected Penalty} = p imes D$

  • Where:

  • $p$ = probability of liability

  • $D$ = damages.

• Firm's Decision Based on Probability:

  • If p < 1 , the firm chooses:

  • $ext{MAC} = p imes ext{MD}$.

  • Low $p$ leads to pollution exceeding efficient levels.

Timeline of DuPont Legal Case

• Key Events:

  • Late 1990s: Lawsuits filed against DuPont.

  • 2004: Settlement funds allocated to scientific study.

  • 2012: Probable link between PFOA exposure and health established.

  • 2017: Major payout to affected individuals.

• Consequences of Delayed Damages:

  • Long delays in damages cause the probability $p$ to become effectively small.

  • Discounting further diminishes deterrent impact.

Common Law Framework of Liability Law

• Definition: Common Law allows courts to determine liability and compensation through lawsuits and legal precedents.

• Standards of Liability:

  • Strict Liability: Polluter responsible regardless of intent or care taken.

  • Negligence: Responsible only if reasonable precautions were not implemented.

• Allocation of Damages:

  • Joint & Several Liability: One party may pay full damages.

  • Proportional Liability: Each responsible party pays only their share.

• Implication of Joint Liability:

  • Increases risk to firms and strengthens deterrence against pollution.

Burden of Proof in Pollution Cases

• Requirements for Plaintiffs:

  • Must establish a direct causal link between pollution and injury:

  • The pollutant must be shown to have caused the damage.

  • The pollutant must originate from the defendant.

• Challenges:

  • Pollution operates probabilistically, complicating the ability to establish direct causes.

  • Meeting traditional standards of proof can be difficult (e.g., proving that a specific cancer was caused by specific pollution).

Statutory Law

• Definition: Statutory law encompasses environmental liability rules codified in legislation.

• Examples of Statutory Law:

  • U.S. Oil Pollution Act (1990)

  • Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund)

• Details Specified by Statutory Law:

  • Who is liable for damages.

  • What damages are covered.

  • How compensation is calculated.

Limitations of Liability Law

• Optimal Conditions for Liability to Function:

  • Harm must be observable.

  • Causation must be clear.

  • Courts must function efficiently (low transaction costs).

  • Firms must expect to pay damages.

• Challenges with Non-Optimal Conditions:

  • Liability may fail to achieve $ext{MAC} = ext{MD}$ when harm is:

  • Diffuse.

  • Probabilistic or delayed.

  • Costly to litigate.

• Alternative Perspective:

  • Rather than asking "Who pays after harm?" we could inquire: "Who holds the right to clean air (or to pollute)?"

Property Rights

• Definition of Property Rights:

  • Exclusivity: Benefits and costs of using the resource accrue to the owner.

  • Transferability: Rights can be exchanged, allowing resources to be allocated to higher-valued uses.

  • Enforceability: Legal institutions protect rights and deter unauthorized use.

The Coase Theorem

• Principles of the Coase Theorem:

  • With clearly defined property rights and zero transaction costs, private bargaining leads to an efficient (socially optimal) outcome.

  • Part 1: Well-defined property rights + costless bargaining + negotiation between parties = socially optimal market quantity.

  • Part 2: The efficient outcome does not depend on which party is assigned the property right, as long as someone is assigned it.

Limits of Property Rights

• Circumstances Under Which Property Rights Can Promote Efficiency:

  • Rights are clearly defined.

  • Transaction costs are low.

  • Enforcement is feasible.

• Limitations of Property Rights:

  • Diffuse harms include many victims and many polluters.

  • High transaction costs can arise from negotiating with thousands of parties.

  • Information asymmetry may lead parties to be unaware of true damages.

  • Free riding occurs when some beneficiaries refuse to pay.

  • Public goods issue arises with clean air affecting everyone.

  • Holdout problem where one party blocks agreement.

Voluntary Compliance

• Definition: Firms may opt to reduce emissions beyond what regulations require.

• Rationale for Voluntary Compliance:

  • Corporate social responsibility motives.

  • Cost savings: Efficiency improvements reduce waste.

  • Response to preferences of "green" consumers.

  • Reputation benefits through product differentiation.

• Key Question: If reducing pollution saves costs, why didn’t the firm already do so?

• Cautions Regarding Voluntary Compliance:

  • Consumers may not observe the true environmental impacts.

  • Marketing claims may not reflect actual environmental performance.

  • Voluntary reductions may not achieve socially optimal outcomes.

Strategic Nature of Voluntary Compliance

• Potential Strategic Uses:

  • Firms may reduce emissions just enough to avoid stricter regulation.

  • Firms might influence or weaken regulations already proposed.

  • Trade-offs between voluntary reductions and reduced monitoring/enforcement may occur.

• Implications for Political Incentives:

  • Voluntary programs can change political incentives without necessarily achieving efficient pollution levels.