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Processes, effects, and the implementation of market-based environmental policy: southern California's experiences with emissions trading
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Processes, effects, and the implementation of market-based environmental policy: southern California's experiences with emissions trading
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PROCESSES, EFFECTS, AND THE IMPLEMENTATION OF MARKET-BASED ENVIRONMENTAL POLICY: SOUTHERN CALIFORNIA’S EXPERIENCES WITH EMISSIONS TRADING by Xueyong Zhan A Dissertation Presented to the FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (PUBLIC ADMINISTRATION) December 2008 COPYRIGHT 2008 Xueyong Zhan ii Dedication To Stephanie, my wife iii Acknowledgements I want to express my deepest appreciation to Professor Shui-Yan Tang, the chairperson of my dissertation committee, for his great supports and encouragements throughout the entire process of my doctoral study. I would like to thank Professor Ronald Henry and Professor Daniel Mazmanian, who have served on my dissertation committee and provided valuable guidance for my research. I also appreciate the comments, suggestions and encouragements from Professors Heather Campbell, Yongheng Deng, Genevieve Giuliano, Elizabeth Graddy, Sheldon Kamieniecki, Derek Kauneckis, Michael Moody, Peter Robertson, Mark Stephen, Guofu Tan and Susan Yackee for my dissertation work. During these years, I have benefited a lot from interactions/discussions with my fellow classmates and colleagues: Xudong An, Mahabat Baimyrzaeva, Jill Cannon, Bin Chen, Francisco G. Delfin Jr., Erlyana Erlyana, Chang Bum Ju, Huanghai Li, Yuan Li, Hui-O Liu, Cathy Yang Liu, Jiaming Miao, Keith Naughton, Celeste Schmid, Yu-Ren Su, Haitao Yin, Feng Wang, Lanlan Wang, Lili Wang, and many others. I am very grateful for their friendship and support. Also, I thank the officials from several environmental agencies and NGOs. The financial supports of the Haynes Foundation Dissertation Fellowship and the Oakley Fellowship are gratefully acknowledged. All errors remain entirely mine. iv Table of Contents Dedication ii Acknowledgements iii List of Tables vii List of Figures viii Abbreviations ix Abstract x Chapter 1 Introduction 1 1.1 Research Purpose 3 1.2 Research Background 7 1.3 Research Questions 11 1.4 Research Methodology and Significance 14 1.5 Organization of the Dissertation 15 Chapter 2 Literature Review 17 2.1 Development of Emissions Trading System 17 2.2 Practices of Emissions Trading 20 2.2.1 National Acid Rain Program 21 2.2.2 RECLAIM 22 2.2.3 Emissions Trading in China 25 2.3 Concerns and Involvement of Stakeholders in Emissions Trading 27 2.3.1 Effectiveness 28 2.3.2 Equity 29 2.3.3 Flexibility 32 2.4 Towards a Better Understanding of Market-based Environmental Governance 33 2.4.1 The Role of Government 33 2.4.2 The Role of Stakeholders 35 2.4.3 Market-based Environmental Governance 35 2.5 Concluding Remarks 37 Chapter 3 The Game of Agency Rulemaking: Political Transaction Costs and Environmental Policy Implementation 38 3.1 Introduction 38 3.2 Literature Review 42 3.2.1 Literature on Public Policy Implementation 43 3.2.2 Mazmanian and Sabatier Framework 44 v 3.2.3 Ostrom’s Institutional Analysis and Development Framework 45 3.2.4 Literature on Political Transaction Cost and Regulatory Design 47 3.2.5 Towards a New Model 49 3.3 A Formal Model of Agency Rulemaking 51 3.3.1 Basic Model in the Coasian World 51 3.3.2 Expanded Model in the Real World 53 3.3.3 Some Further Expansion 57 3.4 Empirical Implications 58 3.5 Concluding Remarks 61 Chapter 4 Stakeholders in Market-based Environmental Governance: Southern California’s Experiences with Rulemaking of Emissions Trading 63 4.1 Background 65 4.1.1 Design and Implementation of Emissions Trading Program 65 4.1.2 The Case of RECLAIM: Implementation and Rulemaking 66 4.2 Theory 70 4.2.1 Stakeholders in Democratic Governance 70 4.2.2 Stakeholders and Agency Rulemaking 72 4.3 Testing the Hypotheses 77 4.3.1 Data 77 4.3.2 Methods 79 4.3.3 Empirical Model 81 4.4 Empirical Results 83 4.4.1 Who Participates in Rulemaking? 83 4.4.2 What Kind of Voices are Expressed? 83 4.4.3 Who is Favored by the Agency? 85 4.4.4 What Kinds of Regulatory Suggestions are Favored? 86 4.5 Discussion 87 4.6 Concluding Remarks 90 Chapter 5 Rules and Effects: An Evaluation of the Implementation of RECLAIM 92 5.1 Introduction 92 5.2 Rules of Emissions Trading: The RECLAIM Case 96 5.2.1 Stakeholders and RECLAIM’s Rulemaking 97 5.2.2 Rules of RECLAIM 98 5.3. A Qualitative Assessment of the Effects of RECLAIM Rules 100 5.3.1 Rules and Incentives for Emissions Trading 101 5.3.2 The Marginalization of NGOs 106 5.4 Assessing the Effectiveness: A Quantitative Approach 109 5.4.1 Research Hypothesis 111 5.4.2 Model Specification 111 5.4.3 Data 114 5.4.4 Empirical Results 116 5.5. Discussion 118 5.6. Concluding Remarks 119 vi Chapter 6 Discussion and Conclusion 122 6.1. Summary of Major Findings 123 6.2. Practical Implications 125 6.3 Theoretical Implications, Limitations, and Future Research 128 Appendices 131 Appendix 1 Minimization Solution to the Political Transaction Cost Function 131 Appendix 2 List of RECLAIM Rules 132 Appendix 3 Variable Descriptions and Coding Strategy 133 Appendix 4 Questionnaire 135 References 136 vii List of Tables Table 2. 1 Comparison of Policy Instruments 24 Table 4. 1 Stakeholder Types of Submitted Issue Comments 83 Table 4. 2 Regulatory Directions Suggested by Comments 84 Table 4. 3 Regulatory Directions (Decomposed) Suggested by Comments 85 Table 4. 4 Testing the Relative Influence of Stakeholders 86 Table 4. 5 Testing the Relative Influence of Stakeholders on Specific Directions 87 Table 5. 1 Annual Permit Allocations and Real Emissions of NO x (1994 – 2006) 103 Table 5. 2 Annual Permit Allocations and Real Emissions of SOx (1994 – 2006) 104 Table 5. 3 Geographical and Period Coverage of This Research 114 Table 5. 4 Effects of RECLAIM on NO x Emission 116 Table 5. 5 Effects of RECLAIM on SO 2 Emission 117 viii List of Figures Figure 3. 1. A Conceptual Model of Policy Implementation Process 50 Figure 3. 2. Policy Preferences of Implementation Agency and Stakeholders 52 Figure 4. 1. Rule Revisions of RECLAIM 79 Figure 5. 1. Permit Allocations and Real Emissions of NO x (1994 – 2006) 103 Figure 5. 2. Permit Allocations and Real Emissions of SOx (1994 – 2006) 104 ix Abbreviations AB 32 – Assembly Bill 32 (California Global Warming Solutions Act of 2006) ARP – Acid Rain Program BACT – Best Available Control Technology CAA – Clean Air Act CAAA – Clean Air Act Amendments CAC – Command-and-Control CARB – California Air Resources Board CAT – Cap-and-Trade CEMS – Continuous Emission Monitoring System EPA – Environmental Protection Agency NO x – Nitrogen Oxides RECLAIM – Regional Clean Air Incentives Market RTCs – RECLAIM Trading Credits SAT – Sulfur Allowance Trading SCAQMD – South Coast Air Quality Management District SEPA – State Environmental Protection Administration SO 2 – Sulfur Dioxide x Abstract This research provides a positive explanation of the implementation processes and effects of market-based environmental policy by conducting a case study on RECLAIM (Regional Clean Air Incentives Market), the first regional emission permits trading program that has been implemented by South Coast Air Quality Management District (SCAQMD) to address air pollution problems in the Los Angeles air basin since 1994. Firstly, I developed a game theoretic model of environmental policy implementation. This model integrates theories of administrative rulemaking, policy implementation, institutional rational choice and transaction cost politics. I argue that administrative agency tries to minimize political transaction costs of policy implementation when writing rules. Based on the formal model, I conducted a quantitative analysis to examine the interactions between SCAQMD and its key stakeholders, such as federal, state and local governments, businesses, and environmental NGOs, during the rulemaking of RECLAIM. I found that SCAQMD is more likely to adopt rule changes suggested by state and federal environmental agencies. This research identifies the dominant role of organized interest groups, the existence of interagency lobbying, and the lack of citizen control over the rulemaking of RECLAIM. Furthermore, I conducted an evaluation of the rules governing the RECLAIM program, and I identify the major distortions of the RECLAIM rules in comparison with an ideal cap-and-trade xi emissions trading market. Also, I used OLS regression to examine the effects of policy difference on emission level in California between 1990 and 1999. This evaluation fails to reject the null hypothesis that using cap-and-trade (CAT) compared with using command-and-control (CAC) has no different effects on emission of both NO x and SO 2 from point sources at the county level in California in the 1990’s. In summary, this research finds that the implementation of emissions trading is political, and interest group politics may distort the regulatory design and implementation of an emissions trading program. While cap-and-trade is promising to better protect our environment and natural resources, its implementation is conditioned by many political and administrative factors. Inadequate rules may come as the results of political compromises, and they may impact the functioning of an emissions trading system. 1 Chapter 1 Introduction Environmental pollution is a major challenge to sustainable development of human society. The emissions of sulfur dioxide and nitrogen oxides can directly cause huge costs to public health. Moreover, these air pollutants may lead to the formation of acid rain that can cause substantial damages to property values. 1 According to the U.S. Environmental Protection Agency (EPA), power plants that use coal and industrial facilities are the two major sources of sulfur dioxide, 2 and motors and industrial facilities are the two major sources of nitrogen oxides. 3 Due to the significant consequences caused by these pollutants, how to control their emissions in the most efficient and effective way has been a major concern of environmental policy. Since the middle of the 20 th century, various policy instruments have been designed and implemented at both state level and federal level to control the emission of air pollutants from power plants, industrial facilities and mobile sources. Many of these policy instruments are characterized by rigid technical and procedural standards (Freeman, 2002). These instruments are also known as the command-and-control 1 For details, see the website of the U.S. EPA, http://www.epa.gov/acidrain/index.html, visited on May 6, 2008. 2 According to the U.S. EPA, “Over 65% of SO 2 released to the air, or more than 13 million tons per year, comes from electric utilities, especially those that burn coal. Other sources of SO 2 are industrial facilities that derive their products from raw materials like metalli core, coal, and crude oil, or that burn coal or oil to produce process heat. ” For details, see the website of Environmental Protection Agency, http://www.epa.gov/air/urbanair/so2/what1.html, visited on May 6, 2008. 3 According to the U.S. EPA, “Nitrogen oxides form when fuel is burned at high temperatures, as in a combustion process. The primary manmade sources of NOx are motor vehicles, electric utilities, and other industrial, commercial, and residential sources that burn fuels.” For details, see the website of Environmental Protection Agency, http://www.epa.gov/air/urbanair/nox/what.html, visited on May 6, 2008. 2 (CAC) regulations, which have dominated in both the U.S. and other countries for several decades. Command-and-control (CAC) instruments are based on the assumption that government has the authority to set the standard of pollutant emission, and polluters have the responsibility to comply with the standard. It is through this mechanism that the goal of pollution control is achieved. In the U.S., various command-and-control instruments have been implemented to control the emission of air pollutants for decades. Although these CAC instruments have helped governmental agencies achieve the goal of environmental protection, criticisms of CAC have been raised, and two of them are the high costs of compliance and the lack of flexibility (York, 2003). Thus, they are criticized as inflexible and inefficient by industrial leaders and economists (Freeman, 2002, Klaassen, 1996). It is under this context that market-based instruments (MBIs) have been introduced by environmental economists and policy makers. Advocates of market-based instruments argue that these policy instruments can effectively produce economic incentives for polluters to improve technology and reduce emissions, and thus they create an efficient and flexible way for environmental regulation (Freeman, 2002, Tietenberg, 2006). As an alternative to traditional command-and-control instruments, market-based instruments have been increasingly adopted and implemented in many areas of environmental and natural resource protection. In recent years, many studies have explored the experiences of implementing various market-based instruments, including emissions trading systems, to address environmental challenges at local, national and international levels (Baron, 2001, Burtraw, 2000, Ellerman et al., 2000, Mazmanian, 1999, Stavins, 1998). 3 However, as Freeman and Kolstad indicate: “…most of the arguments in favor of market mechanisms [in environmental governance] have been based on theory” (Freeman and Kolstad, 2007, p. 3). Stated differently, we do not have enough empirical evidence that supports the superiority of MBIs. For example, the performance of emissions trading has been acknowledged to some extent; yet there are still debates over its effectiveness (Tietenberg, 2006). Also relatively little has been written on the political and administrative aspects of emissions trading. In other words, we still know little about the dynamics of the implementation of this market-based environmental policy, and two major issues that have received little attention are the role of stakeholders in emissions trading programs and the policy effects of emissions trading. With these concerns in mind, in this dissertation I examine the processes and effects of implementation of emissions trading systems, by conducting a case study on Southern California’s Regional Clean Air Incentives Market (RECLAIM). 1.1 Research Purpose The purpose of this dissertation is to examine the political and administrative aspects of emissions trading as well as its effectiveness, and it attempts to provide a positive explanation of market-based environmental policy processes and effects, with a specific focus on cap-and-trade. As well-documented in the existing literature, environmental policy processes usually involve scientific uncertainty, technological complexity, and intensive competition among interest groups (Brewer and Stern, 2005, Jaffe and Stavins, 2007). 4 Environmental policy making and implementation have to rely heavily on both the expertise of bureaucrats and participation of businesses, environmental groups, the academia, and other concerned stakeholders during the policy processes (Cropper et al., 1992, Esterling, 2004, Gregory and McDaniels, 2005, Ringquist et al., 2003). The existing literature has written extensively on the active involvement of various stakeholders in environmental policy making processes (Depoe and Delicath, 2004); yet there are still debates on the influence of specific interest groups over environmental policy implementation process and output (Kamieniecki, 2006, Furlong, 2007). Global climate change and urban air pollutions are among the highly salient issues that have gained increasing public attention at both the national and international levels in recent years (Krosnick et al., 2006). It is evident that whether and how to address these environmental issues have caused intensive public dialogues and policy debates (Hoffmann, 2005). Policy discussions and instrument comparison have led to the adoption and implementation of market-based environmental policy in many places. Nevertheless, market-based environmental policy has not been that popular in the real world due to various political, administrative and technical constraints, although its theoretical advantage of cost-effectiveness is quite apparent. Moreover, even when a cap-and-trade system is adopted, it may come with distorted market mechanisms and/or unsatisfactory effects. For example, many of the existing programs are built on distorted mechanisms, such as the limitations on inter-regional or inter-temporal trading, permit price presetting, standard-based technology requirements, etc. (Foster and Hahn, 1995, Schwarze and Zapfel, 2000, Stevens and 5 Rose, 2002). All of these have significant impacts on the final policy outputs and effects. It is also noticed that existing regulatory contexts or the traditional command-and-control regimes may impact the transition towards market-based environmental governance (Freeman and Kolstad, 2007). The recent literature has already identified the existence of economic transaction costs in emissions trading programs (Stavins, 1995, Woerdman, 2004); yet little has been written on the political processes of regulatory design and implementation of emissions trading, such as the dynamics of issues definition, agenda setting, interest group politics, and agency rulemaking. In other words, the existing literature on environmental governance and policy implementation has paid little attention to “political transaction costs”, a theoretical framework originally proposed by Douglas North (1990) and later developed by Avinash Dixit (1996) for understanding the political process of public policy making and implementation. Some prominent scholars have also called for a comprehensive investigation on processes and players influencing the mechanism design of environmental governance (Dietz et al., 2003, Hahn and Stavins, 1992, Ostrom et al., 1994). It is meaningful to probe deeply into the political and administrative aspects of emissions trading and to ask questions about the regulatory design and implementation processes of market-based environmental governance. As widely acknowledged, public policy making is a process of interest group competition and political compromises (Baumgartner and Jones, 1993, Wood and Vedlitz, 2007), and bureaucratic agencies face a high level of uncertainties in political, legal, technical, and managerial aspects of policy implementation (Kerwin, 2003). 6 Thus, many well-intended public policies or international treaties may encounter unexpected implementation difficulties and end up with unsatisfactory outcomes and even negative unintended effects (Mazmanian and Sabatier, 1989). Therefore, policy making and institutional design require attention to political transaction costs of negotiation and renegotiation activities (Epstein and Halloran, 1999). It is also true for the implementation of emissions trading and other market-based instruments. Compared with traditional command-and-control instruments, market-based instruments rely on quite different incentive structures, which may entail a problem of “incentive compatibility” during the regulatory design process (Dasgupta et al., 1979, Laffont, 2001). Presumably, market-based instruments are more capable of handling the problem of incentive compatibility. However, mechanism design in market-based environmental governance can be more complex, as evidenced by existing experiences of regulatory design and enforcement of emissions trading. Therefore, market-based instruments bring up many challenges to governmental agencies in policy implementation since the incentive structures and institutional constraints of market-based environmental policies are quite different from those of command-and-control instruments. While an implementation agency may be comfortable with command-and-control regulatory style, it may lack adequate knowledge and experience of designing and implementing a market, and thus it may face high levels of regulatory uncertainties, as exemplified in the experiences of emissions trading in the U.S. Acid Rain Program and Southern California’s RECLAIM (Joskow and Schmalensee, 1998, Thompson, 2000, Stranlund et al., 2002). 7 Emissions trading and other market-based policies are not implemented in a zero transaction-cost market. In many circumstances, political and administrative factors create the need for political negotiations and renegotiations, and various stakeholders may influence the formulation and implementation of these cap-and-trade programs as well as the structure of domestic and global environmental governance (Hempel, 1996). Indeed, the democratic nature of American politics provides numerous opportunities for various interest groups to express their voices and to exert their influences on important aspects of emissions trading, such as goal setting, trading mechanism design, enforcement stringency, etc., which may have significant impacts on emission outcomes. This situation is especially true for emissions trading programs implemented at the regional level. One notable example is Southern California’s Regional Clean Air Incentives Market (RECLAIM), which is the first emissions trading program at the metropolitan level that has been implemented for more than a decade, and various interest groups have played important roles in its implementation process (Drury, 1999, Thompson, 2000). RECLAIM’s spatial and temporal scopes make it a very good case for empirically exploring the processes of interest group politics as well as the experiences of applying an environmental policy originally developed from pure economics to real world context. 1.2 Research Background The Greater Los Angeles area, as one of the largest metropolitan areas in the world, has experienced a rapid growth in both population and economy since the beginning of the 20 th century. Along with rapid industrialization and urbanization, this 8 region has also suffered from “being the most heavily polluted metropolitan air basin in the nation” (Mazmanian, 1999, p. 79). The emission of air pollutants, including sulfur dioxide, nitrogen oxides, and particulate matters, has resulted in serious environmental and public health problems. Thus, for decades California has been the frontline of environmental policy making and implementation in the U.S. (Vogel, 1997). Institutional efforts for fighting air pollution in Southern California area can be traced back to the early 1940’s. In 1946, Los Angeles County established the first air pollution control district in the U.S. to deal with air pollution problems (EPA, 2002, p. 5). In 1976, the State of California adopted the Lewis Air Quality Management Act and created the South Coast Air Quality Management District (SCAQMD), which is a special-purpose governmental agency that manages air quality in the Los Angeles air basin, a 12,000 square mile area including all of Orange county and parts of Los Angeles, Riverside and San Bernardino counties (Mazmanian, 1999). Since the middle of last century, SCAQMD has tried to control the emission of air pollutants from power plants, industrial facilities and mobile vehicles, etc. Prior to 1993, the SCAQMD had used command-and-control instruments to address air pollution problems and to make air quality in this region meet both state and federal standards. These efforts had made a huge improvement in air quality in the Los Angeles air basin, however, they were also “laborious and time-consuming”, and the Los Angeles air basin still experienced “excedances of health-based standards for ozone, carbon monoxide, and particulate matter under ten microns” (PM10) (EPA, 2002, p. 5-6). 9 In 1990, the Clean Air Act Amendments (CAAA) was passed as an extension of the Clean Air Act (CAA) of 1977. It is clearly stated in the CAAA that all areas were required to achieve ozone attainment within 20 years. Also market-based instruments, including emissions trading, were strongly encouraged by the CAAA. Los Angeles air basin was the only area in the U.S. to fit into the category of “extreme nonattainment” for ozone (EPA, 2002, p. 5), and NO x is one of the major sources contributing to the formation of ground level ozone 4 (CBE, OBE, v.s. SCAQMD, et al, 2003, p. 14). Thus, the SCAQMD was forced to address the problems of pollution of SO x and NO x . Realizing the difficulties of traditional CAC instruments in emission reduction, the SCAQMD began to consider cap-and-trade (CAT), a market-based instrument to manage the air quality in Los Angeles basin. The RECLAIM program was adopted by the SCAQMD Governing Board on October 15, 1993, with the policy objective to “provide facilities with added flexibility in meeting emissions reduction requirements while lowering the cost of compliance” (SCAQMD, 2004, p.1). As the first region that began to experiment with emissions trading to address air pollution problems, the SCAQMD faced considerable regulatory uncertainties during the regulatory design process. Various interest groups, including federal and state agencies, environmental organizations and business groups, participated in policy dialogues and rulemaking processes. On October 15, 1993, the Regional Clean Air Incentives Market program (RECLAIM) was adopted by the SCAQMD Governing Board, and cap-and-trade was used as the primary instrument. Since January 1, 1994, 4 Ozone is “an air pollutant produced in the presence of sunlight from the primary emissions of NO x and volatile organic compounds in the lower atmosphere” (CBE, OCE, v.s. SCAQMD, et al., 2003, p. 14). 10 RECLAIM program has been implemented in the Los Angeles air basin with higher expectation on emission reduction. The main goal of RECLAIM was to reduce 65% of the emission of sulfur dioxide and 83% of the emission of nitrogen oxides by the end of 2003 (Mazmanian, 1999). Within the cap-and-trade framework, RECLAIM Trading Credits (RTCs) are allocated to industrial plants and power stations and then traded by participants in the market, in which the total emissions (cap) are falling year by year from 1994 to 2003 and then stabilized thereafter. The RECLAIM program focuses on 350 industrial facilities and power plants in four counties: Los Angeles, Orange, Riverside and San Bernardino. After several years of implementation, RECLAIM has achieved quite an impressive reduction of SO 2 , NO x and other air pollutants (EPA 2004, Kamieniecki et al., 1999). During the first ten years of implementation, $683 million worth of emission permits had been traded in the RECALIM (Puri, 2004). Meanwhile, the total number of industrial participants had not changed a lot. However, the effectiveness of emissions trading is not as good as what had been expected at the beginning. One significant event is that during the 2000 California energy crisis, business groups played a significant role in influencing the regulatory agency to revise the cap of total emission permits. In addition to this major revision, the RECLAIM rules have been revised in many aspects with various inputs from citizens, environmental organizations and business groups. 5 5 The SCAQMD has maintained a comprehensive record of rulemaking activities for the RECLAIM program. Records of rulemaking activities include public hearing notices, public comments, rule revisions. They are available at the SCAQMD library. 11 One of the major changes of the RECLAIM program occurred in the summer of 2000, when California energy crisis happened and there was “a sharp and sudden increase in credits prices which had a large impact on the ability of industry to purchase RTCs” (EPA, 2002, p. 1). After that, the SCAQMD Governing Board adopted rule amendments in May 2001 to “stabilize RTC prices” and increased the cap (SCAQMD, 2004, p. 3). Although the RECLAIM program has continued to contribute to the reduction of air pollution in this region in recent years, there still exist some criticism and complaints, such as “the absence of short-term environmental benefit and disincentives in the rules for more active trading” (Mazmanian, 1999, p. 97). It is also found that not all industrial facilities are actively participated in the market (Soleille, 2006). Meanwhile, there have been several lawsuits from environmental groups against the SCAQMD regarding the implementation of the RECLAIM program. For example, two environmental NGOs, Community for Better Environment and Our Children’s Earth, filed a citizen suit against SCAQMD in the September of 2003, arguing that SCAQMD has violated the CAAA and allowed facilities to emit NO x in excess of the amounts allowed by State rules 6 . There is also criticism about the lack of citizen participation in the implementation process (Drury et al, 1999). 1.3 Research Questions RECLAIM’s implementation has raised several intriguing questions that cannot be easily answered by traditional theories of environmental economics and 6 See the website of “Our Children’s Earth”, http://www.ocefoundation.org/press-092903.html 12 policy. Environmental economics textbooks argue that market-based instruments are usually more efficient and more effective than command-and-control instruments; yet these arguments are based on an ideal frictionless setting where transaction costs are zero. In real world settings, the regulatory design and implementation of an emissions trading program is indeed political, and thus interest group politics is intense, and influences from various stakeholders may distort the market mechanism and hamper the functioning of an emissions trading market. This dissertation focuses primarily on the following questions: 1. What is the role of stakeholders in the implementation of a cap-and-trade program? 2. What are the impacts of stakeholders on the regulatory design of a cap-and-trade program? 3. What are the effects of emissions trading on pollutant reduction? Answers to these questions will have significant implications for regulatory design and effective implementation of market-based environmental policies. This dissertation reviews existing experiences with cap-and-trade emissions trading, with a specific focus on the role of stakeholders in the implementation of these programs. Further, I will review the existing literature on stakeholders and market-based environmental governance, and I will use transaction costs theory to develop a game theoretic model of agency rulemaking and public policy implementation. After the theoretical part, I will examine the interest group politics during RECLAIM’s implementation. RECLAIM has been facing the criticism that businesses 13 have exerted an overwhelming influence during the implementation process (Drury et al, 1999). The influence of interest groups on public policy has been well recognized in the political science literature (Yackee and Yackee, 2006). However, the role of interest groups in policy implementation, especially when the governance structure is in transition from a command-and-control style to a market-based one, is not well documented and not fully understood. While the recent years have witnessed the emergence of market-based governance in various policy areas, political scientists and policy researchers still have not fully understood the process and dynamics within this new emerging governance structure, which has created new opportunities and constraints for interest groups in the public policy processes. Do regulatory agencies have a bias toward specific interest groups during RECLAIM’s implementation process? This research attempts to answer this question. Specifically, it will examine the influence of comments from various interest groups on RECLAIM’s rulemaking by analyzing data collected from governmental agencies. Further, this dissertation will look into the policy effects of RECLAIM. In recent years, increasing attention has been paid to the effectiveness of market-based environmental policies. Most of the existing literature, however, has focused too much on economic effects of emissions trading, especially from a business perspective, with little research efforts devoted to the political perspective, such as processes of rulemaking, implementation, etc. There also lacks a systematic study to compare the difference in effectiveness of market-based instruments versus command-and-control instruments, and how rules of emissions trading programs are revised based on inputs from different interest groups during the implementation process. 14 1.4 Research Methodology and Significance This research is informed by the fields of economics, political science and public policy. Based on transaction-cost economics and politics theory (Williamson, 1979, North, 1990, Dixit, 1996), this research develops a formal model of policy implementation by integrating well-developed conceptual and formal models within the literature of public policy implementation (Mazmanian and Sabatier, 1989), transaction cost economics and politics (North, 1990, Dixit, 1996), institutional analysis (Ostrom, 2007), and agency rulemaking (Kerwin, 2003, Yackee, 2005, West, 2005). This research uses both qualitative and quantitative methods to conduct the analysis. I conducted content analysis of archived policy making records, such as statutes, public hearings, public comments on rulemaking and bureaucratic responses. They were coded and transformed into quantitative data for statistical analysis. Also, I conducted interviews with governmental officials and interested stakeholders. Cap-and-trade emissions trading has become a popular topic of policy debates along with increasing public attention to global climate change. In this regard, it is necessary to examine the processes and effects of the implementation of emissions trading so as to better inform citizens and policy makers. This research has significant implications for research on market-based environmental governance in particular and public policy in general. This research is intended to make theoretical contributions to the field of interest groups politics in market-based environmental governance. Compared with the existing literature on market-based environmental policies and interest groups politics, this dissertation has three unique perspectives. First of all, it focuses on SCAQMD, a special-purpose government in a large metropolitan area, 15 which represents a quite different institutional context from the federal context based on which the classical model of public policy process-“iron triangle” model - is built. What’s the role of special-purpose governments in policy implementation? This is an important question that has not been full explored. Special-purpose governments, as non-elected governments, play a very significant role in American public policy process, and now they are also “important subject of academic analysis” (Skelcher, 2007, p. 64). This dissertation will explore the role of special-purpose governments in market-based environmental governance. Second, it captures the transition from command-and-control to market-based governance, an emerging governance structural change that has been greatly promoted but not yet fully explored. Study of this area should have significant implications for future research on and practices of public policy and democracy. Third, it treats rulemaking as a part of policy implementation process (West, 2005), which may improve our understanding of the interaction between interest groups and regulators/legislators. These issues are very crucial to regulators, businesses and NGOs concerning future environmental policy making and implementation. 1.5 Organization of the Dissertation The first chapter is an introduction of this dissertation. Chapter Two reviews existing experiences with the implementation of emissions trading programs, and discusses the role of stakeholders in market-based environmental governance. In Chapter Three, I develop a formal model of agency rulemaking and environmental policy implementation. Chapter Four empirically examines the relationship between 16 stakeholders/interest groups and the implementation of RECLAIM. This chapter explores whether and how stakeholders (including environmental groups, businesses, etc.) have impacted the regulatory agency by submitting comments for rule-revision of RECLAIM during the policy implementation process. Chapter Five evaluates the effects of RECLAIM. Chapter Six concludes with discussion and suggestions for future research and practices of market-based environmental governance. 17 Chapter 2 Literature Review In this chapter, I will explore the role of stakeholders in market-based environmental governance. A literature review on the implementation of emissions trading is conducted first, followed by an analysis of the role of stakeholders in market-based environmental governance. This chapter concludes with a discussion on political transaction costs in market-based environmental governance. 2.1 Development of Emissions Trading System Environmental policy instruments are usually justified by the theory of externality (Buchanan and Stubblebine, 1962, Weimer and Vining, 1992). Externality theory argues that market mechanisms can not effectively and efficiently address negative externalities caused by polluters. Therefore, how to internalize the externalities constitutes a primary focus of environmental policy design. As a conventional response to externality problem, command-and-control instruments are used by government to influence polluters’ behaviors and to achieve environmental goals. Command-and-control instruments can also be called “regulatory approach”, “direct control approach”, or “standards-and-enforcement approach” (Kim, 1995, p. 58). However, command-and-control instruments have been criticized for distorting market prices and lacking efficiency (Freeman, 2002). In contrast to command-and-control instruments, market-based instruments use economic incentives to achieve the goal of environmental protection. The development of market-based instruments has been largely driven by the advocates of economists. As Hempel indicates, economists “have argued that ‘carrots’ (incentives) 18 are more effective than ‘sticks’ (regulatory enforcement) for protecting the environment ” (Hempel, 1996, p. 196). As one of the first market-based instruments, environmental tax or subsidy, also called Pigouvian approaches, was introduced by Pigou and other economists to address the problem of externality (Kim, 1995). Yet Pigouvian approaches were also criticized by Coase. In his historic work on social costs (Coase, 1960), Coase highlights the importance of institutional arrangements of property rights in handling the problem of externality caused by environmental pollution. Based on the economics of property rights, if there are no clearly delineated property rights and well-established rules for transactions of environmental resources, such as clean air, water, etc., transaction costs will be high enough to prevent potential negotiations between polluters and pollution victims. In other words, if the property rights are clearly delineated and transaction rules are implementable, efficiency will be automatically achieved by voluntary transactions. Thus, Coase moves the focus of environmental pollution disputes from externality to property right arrangements and institutional settings. Coase’s work has further paved the way for theoretical development of emissions trading systems. Since 1960’s, a large body of literature of tradable emission permits has emerged in environmental economics and policy. Two of the earliest are Crocker (1966) and Dales (1968), both of which emphasize the necessity of property rights in pollution control and propose to use tradable emission permits for emission reduction. As argued by economists, market-based instruments can provide stronger economic incentive for industrial polluters to improve their 19 technology and reduce pollution emission (Freeman, 2002), and one major example is cap-and-trade (CAT) emissions trading. In cap-and-trade (CAT), the total emission level is set by the government at the beginning and then it will decrease year by year (Joskow and Schmalensee, 1998). Meanwhile, emission permits are allocated to market participants either by auction or grandfathering, and then traded within the market. From the perspective of economics, these emission permits are clearly assigned property rights. Since different participants have different marginal costs of emission reduction, a participant may choose to buy emission permits when market price of permit is below its own abatement cost. The choice between using and trading depends on which way is more profitable for the participant, and thus CAT represents “an environmental policy tool that delivers results with a mandatory cap on emissions while providing emission sources flexibility in how to comply”. 7 Thus, emissions trading has been regarded as a more efficient tool of environmental regulation, and it is expected to be able to provide a better tool for government to control the aggregated environmental outcome. This is why emissions trading has been increasingly embraced by both economists and policy makers in many parts of the world. However, it is also noticed that emissions trading has been “rarely used” for a long time (Joskow and Schmalensee, 1998, p. 37), partially due to the difficulty of implementation or the lack of adequate regulatory capacity. In the following section, I will briefly review existing programs of emissions trading. 7 For details, see the website of Environmental Protection Agency: Cap and Trade: Essentials, http://www.epa.gov/airmarkets/capandtrade/ctessentials.pdf, visited on April 22, 2005. 20 2.2 Practices of Emissions Trading Since the 1970’s, emissions trading system has been designed and implemented in both the U.S. and other countries to control the emissions of sulfur dioxide, nitrogen dioxide, carbon dioxide, and particulate matter, etc. The U.S. EPA is the pioneer of and a major supporter for emissions trading, and the development of emissions trading system in the U.S. was largely stimulated by the enactment of the Clean Air Act in 1970 and Amendments (CAAA) that was passed in 1990. During the 1970’s and 1980’s, the U.S. EPA had experimented with tradable emission permits to address the problem of acid rain. When the Clean Air Act Amendments (CAAA) was passed in 1990, it imposes a much stricter regulation on air pollution, and the Title IV of CAAA mandates that total sulfur dioxide emissions in the U.S. by 2000 must be “reduced by more than 40% of their 1980 level” (Fullerton et al., 1997). The ambitious goals of emission reduction of sulfur dioxides and nitrogen dioxides from electricity industry, which were mandated by CAAA, made conventional command-and-control instruments less attractive and less sustainable. 8 Thus, it became more desirable for government to implement emissions trading system, which led to the adoption of two representative programs in the U.S.: National Acid Rain Program (ARP) and Regional Clean Air Incentives Market program (RECLAIM). At the national level, ARP was established by the U.S. EPA in the 1990’s to regulate sulfur dioxides and nitrogen dioxides emitted from electricity facilities. At the regional level, RECLAIM was adopted by the South Coast Air Quality Management District in 1994 to reduce the 8 For example, Title IV of the Clean Air Act set a goal of “reducing annual SO 2 emissions by 10 million tons below 1980 levels”. For details, please see the website of Environmental Protection Agency, http://www.epa.gov/airmarkets/progsregs/arp/s02.html. 21 emission level of sulfur dioxide and nitrogen oxides in the Los Angeles Air Basin (Kamieniecki et al., 1999). In recent years, some developing countries, such as China, Chile, etc., have also experimented with emissions trading systems to achieve their goal of pollution control (Shuwen, 2004, Montero, 2002, Wang et al., 2002). Market-based instruments are also used by the Kyoto Protocol, an international treaty to reduce the emission of carbon dioxide and address the problem of global warming (Stevens, 2002). 2.2.1 National Acid Rain Program 9 National Acid Rain Program (ARP) has been implemented in two phases: Phase I (1995 to 1999) and Phase II (from 2000). Phase I focuses on the largest electric-generating facilities, which include 110 dirtiest power plants in 21 Midwest, Appalachian, Southeastern and Northeastern states of the U.S., and Phase II focuses on all major electricity-generating plants in the U.S. 10 While ARP regulates both SO 2 and NO x , only the SO 2 program of ARP is based on cap-and-trade (Sulfur Allowance Trading, or SAT). The NO x program still uses rate-based standards (EPA, 2007). Phase II has tightened the cap and covered more than 2000 units. The basic mechanism of National Acid Rain Program is cap-and-trade. By setting the cap of emission level of each year, emission permits are allocated by auctions and then traded by participants with voluntary transactions. Moreover, CEMS (Continuous Emission 9 Information in this section was mostly obtained from the website of Environmental Protection Agency. For more details, please see the website of Environmental Protection Agency, http://www.epa.gov. 10 For details, please see the website of Environmental Protection Agency, http://www.epa.gov/airmarkets/progsregs/arp/basic.html. 22 Monitoring System) is required for all participants so as to ensure the accuracy of emission data provided by these participants. 11 The mandatory use of CEMS has been very important for both government and industrial participants to collect emission information and to avoid cheating behavior in the market. The effectiveness of National Acid Rain Program has been acknowledged by the EPA (EPA, 2002). For example, during Phase I, the sources emitted 28% lower than allocated level on average. 12 Moreover, emissions of sulfur dioxides in 2001 have been reduced by more than 6.5 million tons compared with those in 1980. 13 A recent annual report of the U.S. EPA indicates that “ARP sources have reduced annual SO 2 emissions by 46 percent compared to 1980 levels and 40 percent compared to 1990 levels” (EPA, 2007, p. 8). 2.2.2 RECLAIM RECLAIM covers around 350 point sources, including both industrial facilities and power plants in four counties: Los Angeles, Orange, Riverside and San Bernardino (Mazmanian, 1999). The basic mechanism of RECLAIM is also cap-and-trade. As a regional emissions trading program, RECLAIM has many distorted mechanisms in its design. These distortions include grandfathering allocation of permits, limitation on inter-temporal trading, limitation on inter-regional trading, 11 For details, please see the website of Environmental Protection Agency, http://www.epa.gov/airmarkets/progsregs/arp/basic.html. 12 For details, please see the website of Environmental Protection Agency, http://www.epa.gov/airmarkets/progsregs/arp/docs/clearingtheair.pdf 13 For details, please see the website of Environmental Protection Agency, http://www.epa.gov/airmarkets/progsregs/arp/docs/clearingtheair.pdf 23 mandatory use of CEMS&BACT (Best Available Control Technology), and price cap/intervention. Emission permits are allocated with the principle of grandfathering based on real emission level of each industrial participant in previous years. This arrangement was the result of a compromise between the regulator and business sector, yet it has created serious equity concerns on RECLAIM. Drury et al. (1999) raise several environmental justice issues of RECLAIM. For example, small plants were discriminately treated when only large plants were granted free emission permits; granted emission permits have legalized emissions from these industrial participants; and the potential concentration of pollutions in disadvantaged communities. Further, Drury et al. (1999, 285) suggest that proposed trading should be reviewed and commented by community residents and groups who might be affected by the toxic hot-spot issues. Significant differences in trading rules can be identified in these two emissions trading systems. Although RECLAIM has imposed a higher expectation on emission reduction, its compliance standards are not as strict as those in the national program. For example, CEMS (Continuous Emission Monitoring System) is not mandatory for all industrial participants in RECLAIM, since small business participants could not afford the huge costs of technology improvement and facility installation. While this arrangement provided some flexibility for industrial participants, it induced problem of lax enforcement and even cheating behavior (Stranlund et al., 2002). Moreover, in RECLAIM, the Los Angeles Air Basin is divided into two air zones: one is Coastal Zone and the other is Inland Zone (Kamieniecki et al., 1999). Inter-regional trading 24 from Coastal Zone to Inland Zone is restricted, and banking of unused emission permits for future use is restricted in RECLAIM, while both banking and inter-regional trading are allowed National Acid Rain Program (Schwarze and Zapfel, 2000). In a word, the inter-temporal and inter-regional flexibility of trading is reduced in RECLAIM. A comparison of these two programs is provided in Table 2.1. Table 2. 1 Comparison of Policy Instruments Enforcement Command-and-Control (CAC) Market-based Instruments (MBIs) RECLAIM Phase I of the SAT Phase II of the SAT Mechanism Uniform environmental standards and mandatory compliance Cap-and-trade Cap-and-trade Cap-and-trade Regulated pollutants SO 2 and NO x SO 2 and NO x SO 2 SO 2 Trading rules N/A No banking, restricted spatial trading, price intervention Unrestricted banking and spatial trading Unrestricted banking and spatial trading Coverage Traditional policy instruments Point-sources in Southern California 110 dirtiest power plants All the point-sources in the U.S. Time dimension Before 2000 1994- 1995-1999 2000- Note: Data was obtained from website of the U.S. EPA and the SCAQMD 14 According to the U.S. Environmental Protection Agency, Phase I of the ARP is quite successful; the object sources emitted 28% lower than allocated level on average. The EPA highly values the effectiveness of both RECLAIM and ARP in emission reduction (EPA, 2002 and 2004), and economists also regard the adoption of emissions trading system as a big triumph of economics in environmental policy (Stevens, 2002). The RECLAIM program was adopted with the goal to reduce 65% of the emission of sulfur dioxides and 83% of the emission of nitrogen dioxides by 2003 14 Websites: http://www.epa.gov/airmarkets, http://www.aqmd.gov/reclaim/index.htm. 25 (Mazmanian, 1999). However, RECLAIM did not achieve its original goal of emission reduction of SO 2 . According to a governmental report (EPA, 2002), one of the major reasons for this failure was energy crisis in the summer of 2000 in California. As the result of a sudden increase of demand for emission permits, the price of emission permits rose by more than ten times of that in previous year. Most industrial participants cannot afford the high prices of permits, and the SCAQMD had to increase the cap. This governmental action prevented the permits price from rising and helped resolve the 2000 energy crisis. Market price of pollution control was again distorted by governmental intervention, and political lobbying, rather than technology improvement, may become the first choice for these industrial participants when they face another shortage of emission permits. 2.2.3 Emissions Trading in China For the last three decades, China has experienced a rapid transition from command economy to market economy. One of the major byproducts of its economic development is environmental degradation and pollution. While China’s environmental governance has still overwhelmingly relied on command-and-control instruments, other instruments have been increasingly used in the recent two decades since the economic reform. Since there is no well-established institutional and legal framework in China’s environmental governance system (Shunwen, 2004), the transition costs for regulatory change might not be a major concern for regulatory agencies in China, which can partially explain why Chinese government can embrace emissions trading systems so rapidly. 26 China’s emissions trading experiment was triggered by its policy change in the middle of 1990’s when “Total Emission Control” was adopted by the State Council (Ellerman, 2002). Since the late 1990’s, China has initiated a series of experiments with emissions trading. With the assistance from Resources for the Future, an environmental NGO based in Washington D.C., a regional emissions trading system has been implemented in Taiyuan, Shanxi. As a major industrial city and the No. 1 coal production center in China, Taiyuan is one of the most polluted cities (Shunwen, 2004). For example, its SO 2 concentration level in 2001 was three times higher than the national standard (Wang et al., 2004). When this city formulated a goal of 50% of emission reduction from 2000 to 2005 (Wang et al., 2004), emissions trading system became an attractive and acceptable option. In this program, the State Environmental Protection Administration (SEPA) and the City Government have delegated a lot of authority to local EPA to implement this program (Wang et al., 2004). At the national level, the SEPA has cooperated with the U.S. EPA and Environmental Defense, also a U.S.-based environmental NGO, to conduct feasibility analysis of national emissions trading system and to experiment in Nantong and Benxi, two industrial cities in eastern China (Shunwen, 2004). While it is still too early to identify the effects of these two programs, it is apparent that Chinese policy experiences of adopting emissions trading share the U.S. experience. Firstly, a significant change in environmental goal may provide some strong incentives for adoption of emissions trading. As an effort to meet the goal of Total Emission Control set by the State Council (Shunwen, 2004), the highest administrative entity in China, the embracement of emissions trading system by 27 China’s SEPA is similar to the U.S. EPA’s willingness to promote more market-based environmental governance after the amendment of Clean Air Act in 1990. Secondly, stakeholders may play important role in design and implementation of emissions trading. For example, Chinese government is eager to embrace this innovative policy instrument advocated by foreign governmental and nongovernmental organizations. As documented in the existing literature (Shunwen, 2004, Wang et al., 2004), the U.S. government and the U.S. based NGOs have played a dominant role in this policy transition, which highlights the significant role of international stakeholders in China’s environmental governance. 2.3 Concerns and Involvement of Stakeholders in Emissions Trading As illustrated in previous section, the regulatory structure and process of emissions trading vary a lot across different programs and national settings. According to the economics of emissions trading, if property rights of emissions are established and permits are allocated, the voluntary transactions of emission permits will lead to social efficiency and environmental effectiveness. However, real world implementation processes and effects may be inconsistent with what textbook theory says. Implementation officials are usually faced by different stakeholders who have quite different preferences over how the emissions trading system should be designed. In a democratic society, governmental officials have to be attentive to stakeholders’ legitimate concerns, such as environmental justice, policy effectiveness, regulatory burdens and compliance costs, and more. Therefore, emissions trading systems in the real world usually come with compromises among key stakeholders. 28 In recent years, a large body of literature has explored the impacts of stakeholders on agency behaviors (Doh and Guay, 2006, Friedman and Miles, 2002, Mitchell, et al., 1997). Since the implementation of emissions trading also involves a large number of stakeholders with conflicting preferences, stakeholder theory may provide a unique perspective to analyze the processes and effects of emissions trading. In this research, I use four criteria to explore the concerns of stakeholders: effectiveness, efficiency, equity, and flexibility. 2.3.1 Effectiveness The effectiveness of an emissions trading system in terms of emission reduction is a major concern of all the stakeholders of emissions trading. When the Phase I of National Acid Rain Program was completed, it was declared by the EPA as a success. Kamieniecki et al. (1999) confirms the effectiveness in pollution control of the RECLAIM even when local economic grew rapidly from 1993 to 1996. Yet there are always competing arguments. One example is the doubt on the effectiveness of National Acid Rain Program. Greenstone (2004, p. 609) argues that the 1990 CAAA might not be the major reason for a substantial reduction of emission SO 2 during the 1990’s. Copeland and Taylor (2005) also indicate that Kyoto Protocol is based on the assumption of closed economy. However, in the world of open economy, an emissions trading system is unavoidably subject to free rider problem as “countries outside the agreement increase their emissions in response to the cutbacks of others” (Copeland and Taylor, 2005, p.206). The free rider problem is an inherent difficulty of market design. Since there is no powerful regulatory agency at the global level that could have 29 authority over all participants, the operational efficacy and enforcement mechanism of an environmental market might be in doubt. Therefore, it is not ironic that the U.S., the pioneer of emissions trading, is among the countries that finally chose not to sign on this treaty. One problem that was underestimated in CAT systems is the huge transaction costs induced by inappropriate mechanism design, or the lack of appropriate institutional arrangements (Stavins, 1995). Stavins identifies that there are three categories of potential transaction costs involved in emissions trading systems: “(1) search and information; (2) negotiation and decision; and (3) monitoring and enforcement” (Stavins, 1995, 134). The first category is related to the asymmetric information between permits sellers and buyers. The second category is related to the institutional arrangement of permit transactions, such as governmental procedures, the existence of brokers, legal services, etc. The third category is related to the capacity of regulatory agency to precisely monitor the emission of pollutants. Stavins’s findings have also been confirmed by other scholars. For example, Foster and Hahn (1995) argue that inadequate design of RECLAIM had induced substantial difficulties for industrial participants to get adequate information of trading. Stranlund et al. (2002) also find the lax enforcement of RECLAIM and problematic effectiveness of this program. 2.3.2 Equity Equity is a major concern in policy making and implementation processes. Environmental equity is about the notion that “sources of potential environmental risk 30 may be concentrated among racial and ethnic minorities and the poor” (Ringquist, 2005, 223). The equity of emissions trading systems in democratic societies is still open to question. In emissions trading systems, equity concerns focus on two issues: distributional justice and public participation. Environmental justice is the goal of “remedying the disproportionate burden of environmental pollution and resource degradation experienced by racial and ethnic minorities and poor people” (Drury et al., 1999, p.244). As a public policy instrument, emissions trading has a powerful function of resource distribution. Emission permits, as government-created intangible property rights, are subject to problem of distributional justice, which is based on the assumption that resources should be distributed to all people in a fair way. Auction and grandfathering are the two major methods of emission permits allocation, and government agencies and business participants (industries and brokers) are major players in these processes, while theoretically third parties may also participate in the auctions. While brokers can also benefit from emissions trading, citizens, who have to suffer the major negative consequences of emissions trading, have no power to influence the decision making of governmental and industrial participants, and they have no access to benefit from the trading, and all these have contributed to the formation of environmental injustice in emissions trading (Drury et al., 1999), especially for those people of color or poor (Kamieniecki et al., 1999). Public participation is a prerequisite to guarantee the legitimacy of public policy. With the full involvement of different stakeholders, such as community residents, environmental groups, etc., environmental policy making can be better 31 informed and more democratic. In environmental governance, public participation has “positive institutional functions”, and an increased level of citizen participation is good for better performance of environmental regulation (O’ Rourke and Macey, 2003, P. 383). As “eyes and ears” of the government, community groups and nongovernmental organizations can work with the government to monitor the pollution level of industries (O’ Rourke and Macey, 2003). However, only a handful of articles have paid attention to public participation in market-based environmental governance. Carmen (2002) indicates that the implementation of emissions trading systems provides a new alternative for environmental groups to participate in policy process. For example, many environmental groups purchased emission allowances to directly influence the outcome of National Acid Rain Program, without the use of “lobby or litigate” (Carman, 2002, p. 152). However, these environmental groups can purchase only very limited amount of allowances compared with those traded in the market (Kamieniecki et al., 1999). Thus, the impact of those purchasing activities on overall environmental outcome is relatively limited. On the other hand, there are also criticisms of RECLAIM regarding equity issues, one of which is the lack of citizen participation in emissions trading (Drury et al., 1999). There are also criticisms that emissions trading systems are undemocratic since “only those with substantial wealth can participate in emissions trading schemes, and most citizens have little choice but to stand by and be spectators in the process” (Kamieniecki et al., 1999, p.111). Indeed, there is a lack of comprehensive examination of the role of public participation in market-based environmental governance. On the one hand, while the governance structure is changing from 32 command-and-control to market-based, to what extent public participation can impact the policy making process is less clear. 2.3.3 Flexibility Implementation flexibility is an important feature relevant to both regulators and regulated businesses; yet the level of flexibility varies among emissions trading programs. For example, in RECLIAM, there is no banking of unused permits and a strict restriction on spatial trading. On the contrary, there is no restriction on banking or inter-regional trading in the National SO 2 program (Schwarze and Zapfel, 2000). In Kyoto Protocol, there is also a restriction on trading flexibility, such as limitation on inter-regional trading and banking of permits across commitment periods (Stevens, 2002). These arrangements are not consistent with the idea of unrestricted market mechanism since from the standpoint of economics there is no need to restrict the inter-temporal/inter-regional trading of emission permits. However, political interests, public opinions or other non-economic considerations will support the restriction on trading flexibility (Stevens, 2002). Thus, one may wonder whether many problems in existing emissions trading systems are caused by the lack of a real market. Using a generalized dynamic model, Stevens (2002) finds that there would be the greatest potential gains if there is no restriction on inter-regional trading of emission permits, while a limited potential gains can be obtained from un-restricted inter-temporal trading. However, with a lot of political negotiations and renegotiations involved in the market design and implementation processes, emissions trading has a long way to be an unrestricted free market. 33 2.4 Towards a Better Understanding of Market-based Environmental Governance The experience of emissions trading has shown that stakeholders are strongly concerned with and able to shape the structure of market-based environmental governance. In this regard, students of environmental policy need to pay attention to three scenarios of emissions trading: 1) what a theory predicts; 2) what a policy promises; and 3) what the implementation achieves. While economists may promise that emissions trading may achieve both environmental effectiveness and efficiency, the diverse and even competing concerns of stakeholders may influence the policy implementation of emissions trading, which may explain why the three scenarios of emissions trading may be quite different. As argued by economists, market-based instruments are innovative because they “encourage behaviors through market signals rather than through explicit directives” (Whitten and Young, 2003, p. 2), and thus emissions trading may provide the most efficient way of emissions control. However, emissions trading may experience implementation difficulty and/or the inevitability of market distortion if we do not have a good understanding of the roles of government and stakeholders in market-based environmental governance. 2.4.1 The Role of Government Existing experiences with the implementation of emissions trading has highlighted the difficulty for regulatory agencies to design and implement a cap-and-trade market that incorporates efficiency, effectiveness, equity, flexibility and other stakeholder concerns. Based on neo-institutional economics, inappropriate 34 institutional designs within the emissions trading system may induce huge transaction costs. With the existence of positive transaction costs, emissions trading systems cannot be an unrestricted free market. Thus, emissions trading systems may encounter numerous unexpected problems arising from the real world context since inappropriate institutional designs may induce huge transaction costs. For example, trading activities will be impeded, the emission control costs will be distorted, and thus some emissions trading may not be able to work as the least-cost policy instrument for emission reduction. Moreover, inappropriate arrangements of property rights regime in emissions trading, such as loose initial allocation of permits, may also lead to serious equity problems. These factors could partially explain why the implementation of emissions trading in the real world may not be fully consistent with what economic theory predicts. Atkinson and Tietenberg (1991) indicate that emissions trading system is also subject to market failure. Thus, it is important to set appropriate institutional arrangements and to create appropriate economic incentives, which can structure the behaviors of individuals and industries and thus internalize externality. As Ellerman (2002, p. 1) indicates, “the requirements for establishing an effective tradable permits system do not differ greatly from those for an equally effective tax or command-and-control regime”. Thus, regulatory and implementation capacity does matter for the implementation of cap-and-trade programs. Some political scientists seem to be more skeptical about the role of pure market-based mechanisms. Kamieniecki et al. (1999, p. 120) argue that “not all environmental problems lend themselves to the use of market incentives”. It is true that “while MBIs offer promise they are not a panacea” (Whitten and Young, 2003, p. 35 4). As Hempel (1996) indicates, market-based solutions cannot resolve environmental problems, and a combination of different instruments “may indeed be optimal” (Hempel, 1996, p. 197). Since governmental agencies have always played a major role in environmental governance, it is important to have a facilitative government in a well-functioning emissions trading system. 2.4.2 The Role of Stakeholders A major weakness of the existing literature on emissions trading systems is that it fails to identify the new roles of governments, businesses and NGOs in emissions trading systems. While a handful of articles have identified the changes of participants’ behavior in this innovative regime, most of them are descriptive work. There is a lack of understanding of the institutional context of emissions trading systems. What kind of circumstances will facilitate/impede the implementation of an emissions trading system? In this regard, we need to better understand new roles of government, businesses and NGOs in market-based environmental governance. 2.4.3 Market-based Environmental Governance The implementation of emissions trading programs can be better understood within the context of environmental governance. With the introduction of governance into political science and public policy research, the concept of environmental governance has also drawn a lot of attention from policy-makers and political scientists in recent years (Durant et al., 2004, Hempel, 1996, Kettl, 2002). In other words, implementation of emissions trading programs may require favorable political climate, adequate regulatory capacity and appropriate market design. 36 Hempel defines global governance as “people, political institutions, regimes, and nongovernmental organizations (NGOs) at all levels of public and private policy making that are collectively responsible for managing world affairs” (Hempel, 1996, p.5). Based on this definition, environmental governance may actually include multiple participants, multiple institutional arrangements as well as multiple levels. Market-based environmental governance is inherently political in its nature and cross-sectoral in its structure. The use of market-based instruments calls for a redefinition of traditional roles played by governments, businesses and NGOs in environmental regulation, and it has also greatly increased the necessity of cooperation between different sectors. Although market-based instruments might “forge generally constructive partnerships between the public and private sector as well as between different government levels and agencies”(Kamieniecki et al., 1999, 120), it is not well-understood in what kind of institutional arrangements or under what circumstances these partnerships can be effectively facilitated and eventually forged. Moreover, the emergence and development of emissions trading systems as well as other market-based instruments have greatly changed the way of public participation, and it is still uncertain how to effectively engage different stakeholders in market-based environmental governance. On the other hand, it is important to facilitate the collaboration among different sectors, which is essential to political compromises, administrative feasibility and efficient trading within market-based environmental governance. Stated differently, a well-functioning environmental market needs adequate design of its structure to mitigate political transaction costs, administrative/organizational costs, and economic transactions. 37 2.5 Concluding Remarks This chapter has identified a lot of weaknesses of existing research on emissions trading. It also calls for a better understanding of the important role of stakeholders in emissions trading. Based on the achievements made by existing emissions trading systems, I argue that emissions trading, as an innovative policy instrument, is promising for modern societies to better protect our environment and natural resources, yet the implementation of an emissions trading system is conditioned by many transaction costs issues or political and administrative factors, and the regulatory challenges are huge. As Stavins (2007, 24) indicates in his comments on the Market Advisory Committee’s report, the “Devil is in the details”. People can still be optimistic about the future of emissions trading systems, yet more attention should be paid to details of mechanism design and institutional factors of cap-and-trade emissions trading systems. 38 Chapter 3 The Game of Agency Rulemaking: Political Transaction Costs and Environmental Policy Implementation 3.1 Introduction One of the major concerns within the literature of environmental policy is the failure of policy implementation. Since the publication of Pressman and Wildavsky’s groundbreaking research on policy implementation (Pressman and Wildavsky, 1973), the field of policy implementation has grown rapidly; and recent years have witnessed a large number of implementation studies in almost every policy subfield, such as health, education, environment, public infrastructure, and more (Saetren, 2005). It is well acknowledged that implementation is a significant step of public policy processes and key to policy successes. While the existing literature has identified various sources of policy implementation failures, one of the major weaknesses of existing theories of policy implementation is that they have proposed too many models and variables (O’Toole, 1986 & 2000). The field still lacks either the conceptual clarity or consensus for a fundamental theory of policy implementation (O’Toole, 2000, deLeon and deLeon, 2002). Indeed, we only have an incomplete story of public policy implementation (Saetren, 2005), and Pressman and Wildavsky’s puzzle of policy implementation failure remains largely unanswered. O’Toole (2000, p. 273) argues that “the core question of policy implementation” is “what happens between the establishment of policy and its impact in the world of action”, and he further suggests the potential of applying game-theoretic logic in implementation studies. According to Pressman and 39 Wildavsky (1973), public policy implementation involves extensive negotiations and bargaining between various stakeholders, and thus implementation research requires attention to political negotiations/renegotiations and institutional arrangements within the process of policy implementation. Therefore, a theory of policy implementation needs to address mechanism design and strategic interactions between agencies and stakeholders. In recent years, economists have also attempted to understand public policy processes from the principal-agent perspective. It has been well acknowledged in the existing literature that information asymmetry is a major barrier to effective policy making and implementation, and incentive compatibility becomes a major constraint to policy processes (Laffont, 2001). With an attempt to integrate various perspectives on policy implementation, this paper develops a formal theory of policy implementation by using agency rulemaking as an alternative perspective. I argue that the existence of political transaction costs may impede policy implementation, and thus the major role of bureaucratic agency is to minimize political transaction costs during the rulemaking and revision processes. This paper focuses primarily on environmental policy, a public policy subfield that has encountered many implementation problems. As we know, clean air, water, and other environmental goods are important to the daily life of all human beings. Yet the provision of environmental goods has been a difficult task, partially due to the difficulty in collective action (Olsen, 1971). Although the movement of natural resources conservation can be traced back to the 19 th century, only the recent five to six decades have witnessed massive governmental efforts to protect the environment at the institutional level in both the developed and developing worlds, with the increasing 40 adoptions of innovative environmental policies and agencies at the local, national and international levels. For most of the time it is government that assumes the primary responsibility of this provision. Meanwhile, environmental organizations and business groups have also been, voluntarily or involuntarily, playing an active role in environmental governance (Dixit and Olson, 2000, Kamat, 2004). Nevertheless, how to address environmental changes has continued to be one of the most important challenges to our future. Forty years after the publication of “The Tragedy of the Commons” (Hardin, 1968), this tale still has its legacy for the era of globalization, even though in many places there are well-designed environmental policies in hand and comprehensive establishment of regulatory systems in place. Why is the provision of environmental goods so difficult? In other words, why is collective action so difficult and why does the environmental administration fail under many circumstances? In recent years, there are increasing questions raised by citizens, environmental groups, and policy scholars regarding environmental policy implementation. To implement environmental policies, various incentive mechanisms have been designed to make these policies work. For several decades, environmental policy implementation has been dominated by the “command-and-control” tradition. Governmental agencies have set up environmental standards and mandated industrial compliances. Yet this approach has been criticized by economists for the lack of flexibility and high costs of compliance (Freeman, 2002). Over the years, numerous incentive-based instruments have been proposed and implemented in various arenas of environmental governance, such as environmental tax, emissions trading, voluntary 41 compliances, etc. In recent years, market-based environmental policies have been increasingly used to address global and local environmental challenges. However, it is still less known to all how these innovative policies are implemented in the real world. Traditional practices of environmental policy and administration have also largely ignored the problem of institutional arrangements. For example, the command-and-control paradigms have relied on central administrative agencies with one-size-fit-all policies, and this implementation mechanism overlooks the diversity of organizational structures and institutional contexts among the implementation agencies. The last twenty years have witnessed an increasing diversity in governance structures, such as the increasing importance of local governmental agencies in policy implementation and the rise of decentralized implementation (Whitford, 2007). Along with the rise of innovative instruments and decentralized implementation, recent years have also witnessed the rise of non-traditional actors, such as international organizations and special districts, in environmental governance (Foster, 1997). The implementation of market-based policies has also relied on non-traditional governments. For example, European Union Emission Trading Scheme (EU ETS) is implemented by European Commission, a super-national entity. In the U.S., South Coast Air Quality Management District (SCAQMD) –a special-purpose government-has also been the implementation agency of the Regional Clean Air Incentives Market program (RELCAIM) in the Los Angeles Air Basin (Kamieniecki et al., 1999, Mazmanian, 1999). As legislators increasingly delegate policy power to bureaucrats (Huber and Shipan, 2002), it is not surprising that non-traditional 42 governmental entities, such as special-purpose governments, play a more and more important role in the decentralized policy implementation framework. The increasing diversity of policy instruments and implementation agencies has raised intriguing questions regarding incentive compatibility and institutional adaptation of environmental governance. For example, how is the problem of incentive compatibility addressed in market-based environmental policy? How do the institutional structures of an implementation agency impact the regulatory structure, the policy implementation process and the policy outcome? Since the implementation of market-based environmental policy relies on a more complex incentive structure, it is not surprising that implementation agency may face more problems of incentive compatibility, which is the major focus of regulatory design or agency rulemaking. Based on existing frameworks of policy process, I will present a political economy model to analyze the role of agency rulemaking during the policy implementation process. 3.2 Literature Review In this section, I will review the existing literature on policy implementation/process, mainly the Mazmanian-Sabatier Framework (1980&1989) and Elinor Ostrom’s Institutional Analysis and Development framework (1999&2007). Then I will analyze the implications of transaction cost politics theory for understanding the dynamic interactions between agencies and stakeholders in policy implementation. 43 3.2.1 Literature on Public Policy Implementation Political economists have tried to understand the regulatory process from the perspective of principal-agent relationships (Bergman and Jan-Erik, 1990, Miller, 2005, Weingast, 1984), arguing that there are incentives for implementation agencies (agent) to break their commitment and thus fail to fulfill the policy goals established by the legislative body (principal). One of the major reasons, as indicated by Laffont (2001, p. 7), is that governmental officials “are very much constrained by law and by the democratic rules, which allow a majority to change the rules” 15 . In other words, constitutional structure or political arrangements may constrain the full implementation of policy acts/mandates by governmental agencies through regulatory processes. Some scholars are pessimistic about agency effectiveness in policy implementation. One of the most important arguments raised by political scientists regarding bureaucratic effectiveness is Moe’s assertion that “American public agency is not designed to be effective” (Moe, 1989, p 267). Moe further argues that regulatory agencies are designed to fail because Congress-created regulatory agencies are subject to interest group politics (Moe, 1989). Furthermore, Miller and Hammond (1994) argue that officials may not implement the most efficient policy if it is not of their best interests, and “no smoothly-running, apolitical system of self-interested actors can supply an efficient level of public goods” (Miller and Hammond, 1994, p. 24). These arguments highlight the difficulty of effective policy implementation and illuminate 15 Here “law” refers to the structure of the political system, while “rules” refer to the specific details of legislative and administrative procedures. 44 the political nature of policy implementation. However, these theories ignore the large variation among agency types and policy areas, and they also overlook the adaptive capacity of bureaucratic institutions. 3.2.2 Mazmanian and Sabatier Framework Since the 1970s, numerous frameworks have emerged to understand the policy implementation process, such as the Mazmanian and Sabatier policy implementation framework (1989), street level bureaucracy (Lipsky, 1980), advocacy coalition framework (Sabatier, 1988), etc. Among these models, the Mazmanian-Sabatier Framework is regarded as “the most widely accepted” approach by “incorporating some ‘bottom-up’ concerns into ‘top-down’ analytical frameworks” (Ryan, 1996, p. 34&35). By using statute as the key benchmark, Mazmanian and Sabatier (1989) construct a conceptual framework that integrates the characteristics of policy problem, statutory variables and non-statutory variables for understanding the policy implementation process. In this framework, statute “constitutes the fundamental policy decision being implemented in that it indicates the problems (s) being addressed and stipulates the objectives (s) to be pursued” (Mazmanian and Sabatier, 1980, p. 10). Though this treatment presents a clear benchmark for understanding of the policy implementation process, its primary focus on the formal institutional structure lends it to critiques of a strong top-down orientation and rigidity. For example, Ryan (1996, p. 40) criticizes that Mazmanian and Sabatier’s framework (MSF) is limited due to their less attention to the political processes during which the interaction between stakeholders and implementation agencies affects policy outcomes, which are better 45 addressed by other “bottom-up” implementation scholars. Schofield also argues that the MSF is “not contingency responsive” and “loses much of its analytical capacity in periods of uncertainty and rapid policy innovation” (Schofield, 2001, p. 250). Moreover, the MSF does not clearly distinguish rules-in-paper (statute) and rules-in-use, and thus to some extent it overlooks the process of institutional change and the role of informal institutions, all of which may impact the policy implementation process and outcomes. Thus, the institutional analysis literature, which pays special attention to the informal institutional arrangements, may benefit the further development of the MSF. 3.2.3 Ostrom’s Institutional Analysis and Development Framework Although there is no well-established framework for policy implementation within the institutional analysis literature, extensive efforts have been devoted to the structure and process of governance and institutional change (North, 1990b, Williamson, 1979). Some scholars have applied institutional rational choice theory to examine the evolution of American bureaucracy (Zegart, 1999, Durant, 2006). One of the most important schools in this tradition is the Indiana School of Institutional Analysis initiated by Vincent and Elinor Ostrom since the 1960’s. Elinor Ostrom (1999&2007) provides an Institutional Analysis and Development (IAD) framework for understanding of the institutional rational choice in policy process. This framework clearly distinguishes rules-in-use from rules-in-form. Rules-in-use is thus treated as a core variable and defined as “…the dos and don’ts that one learns on the ground that may not exist in any written document” (Ostrom, 2007, p. 23). The IAD framework 46 argues that the physical world and community conditions will work with rules-in-use to constrain policy action and the interactions among policy actors at the constitutional, collective-action and operational levels (Ostrom, 2007). Although the IAD framework does not focus primarily on policy implementation, it provides a more comprehensive framework of policy process and covers both the formal and informal processes of institutional choice. Since its first edition published in 1999, the IDA framework has been applied by more than thirty studies in many policy areas, such as environmental protection, banking reform, international development assistance, etc., within both the developed and developing countries (Ostrom, 2007). Yet the IAD framework also has some limitations. While the rules-in-use variable provides a more practical perspective for understanding the role of de-facto institutional arrangements in the policy process compared with the statute variable in MSF, it pays little attention to how and to what extent rules-in-use are connected to rules-in-form. In other words, it is unclear how statutes are transformed into rules-in-uses, and this process may have impacts on policy implementation. Moreover, the top-down orientation of the IAD framework as a rational choice theory also limits the explanatory power of institutional change (Durant, 2006). Thus, while both the IAD framework and the MSF are powerful frameworks of policy process, both of them are limited in the aspect of institutional change. Yet combined together they may lend some theoretical leverage to understanding of institutional change during the policy implementation process. It is with this hope that this paper attempts to provide a political transaction-cost theory of policy implementation to understand the institutional process, with specific application to market-based environmental policy. 47 3.2.4 Literature on Political Transaction Cost and Regulatory Design Policy implementation has to rely on implementation rules that can be enforced by agencies. However, an implementation agency usually faces many regulatory uncertainties (Kerwin, 2003). Thus, rulemaking, as a main tool of designing optimal incentive mechanisms for implementation, is often used to mitigate the problem of information asymmetry. The U.S. 1944 Administrative Procedure Act establishes three main types of agency discretions: “rule making, adjudicatory hearings, and discretionary actions (also known as informal rule making)” (Epstein and Halloran, 1994, p.702). The rulemaking process involves intensive political negotiations/renegotiations between key stakeholders and entails a lot of political transaction costs. The concept of “political transaction cost” is originally borrowed from the literature of transaction cost economics, which focuses on the costs of measuring and enforcing contractual and organizational arrangements in economic markets (Coase, 1937, Williamson, 1979). Transaction cost economics has been successfully applied to the study of contracts and firms, and its unique perspective may lend some leverage for political scientists in understanding the political process. North (1990a) argues that transaction costs are even more significant in the functioning of political markets. In recent years, this line of thinking has been extended into the study of politics, and numerous scholars have written on the role of political transaction costs in political arrangements and policy making (Dixit, 1996, Epstein and O’ Halloran, 1999, North, 1990a, Wood and Bohte, 2004). However, its application in public policy and administration remains limited, partially due to the fact that problems faced by public 48 sector agencies are more complex, with a “multidimensional, multiprincipal nature” (Dixit, 2002, p. 722). Environmental policy implementation faces similar problems. In real world settings, environmental agencies usually have discretions in regulatory design and enforcement. Under many circumstances, however, they do not have the full information of regulated industries and other related stakeholders, and thus they face considerable technological and legal uncertainties. Therefore, they still need to tackle incentive compatibility problems in regulatory design and enforcement. The formulation and implementation of market-based environmental policy is a good case for the application of theory of political transaction costs. The design of a market is a complex task that usually requires more expertise, information and resources than making a contract in economic markets. The implementation agency and stakeholders have to work together to establish specific rules, and it is also natural that even after the policy is enacted, there are still difficulties of collecting information, monitoring regulated parties and enforcing rules in an environmental market. Negotiations and renegotiations happen in many cases, and they may entail rule revisions. Use the cap-and-trade emissions trading as an example. Theoretically, if emission permits are allocated and policy target (cap) is set, the participants will automatically enter into trading activities (buying or selling emission permits) based on the marginal abatement cost curve (Freeman, 2002, Tietenberg, 2006). These assumptions about emissions trading rules are based on a frictionless world where transaction costs are zero. But the real world experiences of implementation differ from an ideal scenario. For example, regulatory 49 agency may find it very difficult to set up an emission cap that is acceptable to all stakeholders; industries may debate on trading mechanisms; environmental groups may be upset by loose enforcement of trading mechanisms and “hot-spot” issues, etc. In market-based policy implementation, the existence of economic transaction costs can impede information sharing and permit trading. Thus, the performance of some emissions trading programs may be adversely affected (Foster and Hahn, 1995, Stavins, 1995). Moreover, the implementation process of emissions trading also involves property rights definition, trading mechanism design, and renegotiation, all of which entail substantial transaction costs that are political in nature. Therefore, in many cases both the implementation agency and some key stakeholders have to renegotiate the implementation rules and to make compromises to move the policy implementation process. In this section, I provide a model of agency rulemaking that integrates the concepts of political transaction costs. 3.2.5 Towards a New Model It takes a long way for a good causal theory to become a policy statute. In many cases the statute, even though deliberately designed and legally passed, may not create the optimal incentive mechanism-the rules-in-use-for effective and efficient enforcement of the original policy goals. Statutes are developed from causal theory and written on the paper, while rules-in-use are always based on the ground in real-world settings. Thus, there is always tension between the statute/mandate and the rules-in-use. I formulate a conceptual model of policy process that capture this tension and the political dynamics of institutional/rule changes in policy implementation 50 processes. It complements both the MSF and IAD and suggests that the interaction among rules-in-theory, rules-in-paper (statute), and rules-in-use is the key to understand the policy implementation process (Figure 3.1). Figure 3. 1. A Conceptual Model of Policy Implementation Process Based on the premise that the existence of huge political transaction costs may impede an effective formulation and implementation of environmental policy, the model may be used to examine the interactions between various stakeholders and environmental agencies during the rulemaking process. Specifically, it calls for scholarly attention to how the strategic interactions between agencies and stakeholders have shaped the rules during rule formation and rule revision stages. On the one hand, this model suggests that there is always a distance between rules-in-theory and a statute. Thus, there are substantial political transaction costs during the process of transforming a causal theory to a policy statute. Under special circumstances an administrative agency will be created as an institutional response to convert an innovative causal theory to a feasible policy statute. On the other hand, there is always a distance between a statute and its rules-in-use, Thus, there are substantial political transaction costs during the process of policy implementation, and an administrative agency will need to revise the original rules. Based on the analysis above, a formal model of agency rulemaking and policy implementation is further constructed. Statute Rules-in-use Rules-in-theory Rule formation process Rule revision process 51 3.3 A Formal Model of Agency Rulemaking In this section, I provide a model of agency rulemaking that integrates the concepts of political transaction costs. This model treats rulemaking as an essential part of policy implementation, an approach proposed by West (2005). The main problem faced by bureaucrats/rule writers is to find policy preferences of key stakeholders and to design an optimal rule or mechanism for policy implementation. I will develop this model step by step, proceeding from a Coasian world to a real world setting. 3.3.1 Basic Model in the Coasian World The basic model is in a Coasian world, a scenario in which the costs of information and negotiation are zero (Dixit and Olson, 2000). Thus, agency rulemaking in the Coasian world entails no information costs and negotiation costs. A bureaucratic agency can freely identify the policy preferences of all influenced parties and stakeholders. We can also assume that all stakeholders are treated equally by the agency. For simplification, the basic model deals with a one-dimensional policy space, an approach frequently used in previous research (Epstein and O’ Halloran, 1999, 53). This means that policymakers need to make a decision on a single rule or a policy issue, which can be an optimal emission level, a technological standard, a data reporting method, or an optimal level of emission fee, etc. I also assume that political participation costs are zero in the basic model, which means stakeholders can costlessly report their policy preferences to rule writers. Consider a policy issue P with 52 an environment consisting of one bureaucratic agency, and all n stakeholders (i=1, …, n). Stakeholder i may be a firm, a nonprofit organization, a legislative body, an external governmental agency, or any other stakeholders. During rulemaking, an agency needs to formulate an optimal policy state. Here, θ * ∈R R R R denotes the ideal policy state preferred by the bureaucratic agency, whose discretion is constrained by a policy range of [θ L ,θ H ], which is usually set by either a legislative body or its administrative autonomy. Each stakeholder has a most-preferred policy θ i ∈R R R R. Figure 3-2 is a description of the distribution of policy preferences within the one-dimension policy space. Figure 3. 2. Policy Preferences of Implementation Agency and Stakeholders As required by the Administrative Procedural Act, rule writers need to consider inputs from concerned parties of rulemaking. Thus, it is quite possible that the agency may not be able to choose its ideal policy state θ * . Instead, the agency needs to integrate public preferences based on some strategy. We can firstly assume that rule writers use a purely democratic strategy, in which all stakeholders are treated equally. Thus, the policy output θ A will be: θ θ L θ H θ * θ 1 θ 2 θ 3 …… …… θ n-1 θ n 53 θ A =θ * + ∑ = n i 1 (θ i –θ * ) , s.t., θ A ∈ [θ L ,θ H ] (3.1) The basic model does not consider transaction costs. Yet in the real world, this democratic strategy may not even be used. During rulemaking activities, rule writers have to face information costs and negotiation costs; and stakeholders also have to face participation costs. In other words, the real world is a non-Coasian world with transaction costs. 3.3.2 Expanded Model in the Real World In real world settings, an implementation agency faces substantial political transaction costs, and stakeholders may have to make choices on whether and how to participate in policy making and implementation, and strategic interactions between agencies and stakeholders can be observed before and after a rule is enacted. Specifically, rule writers would expect to face political resistance from stakeholders, and stakeholders need to decide on whether to influence the rule writers. Thus, an expanded model of agency rulemaking integrates various political transaction costs, and it needs to consider the strategic interaction between rule writers and stakeholders, or the “game of agency rulemaking”. Suppose rulemaking proceeds through the following sequence: (1). Legislators establish a policy statute/mandate, and then they delegate it to an implementation agency. With a preset range of discretion [θ L ,θ H ], this agency may choose a policy output θ∈ [θ L ,θ H ]; 54 (2). Bureaucrats are charged with the implementation task, and rule writers announce a proposed policy state θ * ∈ [θ L ,θ H ] to test the public preferences; (3). If the expected loss is higher than participation cost, a stakeholder will submit a comment with a policy preference θ i to the agency, otherwise, a stakeholder will keep silent; (4). Based on solicited public preferences and this agency’s stake in policy implementation, rule writers choose a policy state θ A ∈ [θ L ,θ H ] or withdraw this rulemaking. Denote the utility function of each stakeholder of this policy as U i , with i=1, 2, 3,…, n. Recall each stakeholder’s policy preference is θ i ∈R R R R. Thus, U i = - (θ i –θ) 2 (3.2) While utility function provides a way to describe the positive/negative impacts of a public policy state on stakeholders, the difficulty in comparing utilities of different stakeholders requires a transformation from utility to comparable concepts. It is apparent that a stakeholder will be more likely to be upset and initiate a political action if one’s preference is farther from the proposed policy state. Thus, political power and participation costs are integrated into this model. The integration of political power Suppose that more political resistances would be observed if a stakeholder’s expected loss increases. Thus, I provide a definition of political transaction costs: the political resistance imposed by stakeholders on regulators. Since it is apparent that not all stakeholders suffer/benefit at the same level, they will show different amounts of 55 political resistance to any single policy state. And it is unlikely that regulators will treat all involved stakeholders the same. Thus, the assumption that all stakeholders are treated equally by the agency may not hold. Indeed, the opinions of stakeholders are treated differently because they have different levels of losses/benefits, different levels of technical expertise, and more importantly, they have different “political power” (Noll, 1989). Thus, expected political transaction costs can be defined as the following: E(P i )=β i (θ i –θ) 2 (3.3) β i is a vector that denotes the political and technological characteristics of a stakeholder. In other words, a stakeholder’s comment will be more influential if a stakeholder holds more political power or technical expertise/credibility. Also, a stakeholder’s comment will be counted more if he/she will benefit/lose more than other stakeholders. The integration of participation cost Participation costs also constitute a major constraint for participation in policy and political processes (Acemoglu, 2003, Dixit, 2003). During agency rulemaking, stakeholder i may face a political participation cost function T (x i ,θ * ). P i (·/T i ) is a Bayesian decision rule for stakeholders who need to decide whether to participate in agency rulemaking. β i [ (θ i –θ) 2 –T i ], if T i <= (θ i –θ) 2 E(P i /T i )= 0, if T i > (θ i –θ) 2 (3.4) 56 Thus, it is safe to assume that many stakeholders may choose to keep silent during the rulemaking period. I can also assume that many stakeholders may participate in different stages of rulemaking. In any event, it is safe to assume that among the n stakeholders, only m ∈R R R R (m<n) of them will submit public comments indicating policy preferences. The outcome of agency rulemaking After collecting public comments, the agency has to choose a new policy state. Now we can formulate the political transaction cost minimization problem. Given a proposed policy state, the regulatory agency wants to find an acceptable policy state θ∈ [θ L ,θ H ] that minimize the political transaction cost function: C(θ,θ * )=α(θ * -θ) 2 + ∑ = m i 1 E(P i ) =α(θ * -θ) 2 + ∑ = m i 1 β i [ (θ i –θ) 2 –T i ] (3.5) Here α denotes that bureaucrats also have a stake in policy implementation, which means that an agency will try to implement a public policy to achieve its organizational mission. Stated differently, bureaucrats are also self-interested. This assumption is different from either the public interests theory of regulation or the capture theory. Indeed, this model assumes that bureaucrats implement a public policy primarily for their own benefits, such as promotion, job security, self-achievement, etc. Then, the optimal cost function C * is defined by C * (θ,θ * )=min C (θ,θ * ), θ∈[θ L ,θ H ] (3.6) 57 The final policy output will beθ A : Rule Withdrawal, if (α*θ * +∑β i *θ i )/ (α+∑β i )<<θ L θ L , if (α*θ * +∑β i *θ i )/ (α+∑β i )<=θ L θ A = (α*θ * +∑β i *θ i )/ (α+∑β i ), ifθ L < (α*θ * +∑β i *θ i )/ (α+∑β i )<θ H θ H , if (α*θ * +∑β i *θ i )/ (α+∑β i )>=θ H Rule Withdrawal, if (α*θ * +∑β i *θ i )/ (α+∑β i )>>θ H Its solution is given in Appendix 1. 3.3.3 Some Further Expansion In the expanded model, the agency’s objective is to implement a public policy at the minimal level of political transaction costs. Yet rule writers may also have to consider the integration of inter-temporal policy transaction costs. In other words, agency rulemaking is not a one-round game. Instead it may involve multiple stages and numerous rule revisions. We can assume that rule writers will face a finite number of stages of rulemaking in the future. Denote the discount factor of stage j of future rulemaking as δ j ∈ (0, 1), with j=1, 2, 3,…, k. Then, the optimal cost function C * can be defined by C(θ,θ * )= ∑ = k j 1 δ j {α j (θ j * -θ j ) 2 + ∑ = mj i 1 E(P ij )} = ∑ = k j 1 δ j {α j (θ j * -θ j ) 2 + ∑ = mj i 1 [β i (θ ij –θ j ) 2 –T ij ] } (3.7) Its solution would be similar to that of the one-shot game of (5). 58 3.4 Empirical Implications For a long time, the influence of external stakeholders on agency rulemaking had been regarded as trivial in the existing political science literature (Jewell and Bero, 2007). In recent years, political scientists and policy scholars have paid increasing attention to agency rulemaking activities, and some empirical studies do identify the significant role of public participation in influencing rulemaking outputs through the notice and comment procedures (Cuéllar, 2005, Golden, 1998, Jewell and Bero, 2007, Yackee and Yackee, 2006). While these studies improve our understanding of agency rulemaking, most of them only focus on specific agencies and a limited number of rules, which limits the generalizability of their findings. We still lack a formal theory of rulemaking. As indicated by Kerwin, rulemaking “is an area in which the academic community lags behind practitioners” (Kerwin, 2003, p. 284). The formal model of agency rulemaking developed in this article may contribute to theoretical and empirical research of agency rulemaking and policy implementation. One unique characteristics of this model is that it integrates the processes of regulatory design and implementation, with the focus on rulemaking. In the scenario of multiple-stage rule revisions, it may also incorporate policy evaluation and rule revision. Thus, this model avoids the singular focus on one stage in previous models of formulation, implementation and evaluation, as exemplified in traditional policy process models. Also, its focus on dynamic interactions between agencies and stakeholders also avoids the debates between “top-down” and “bottom-up” approaches (Matland, 1995). Thus, it may help better understand the strategic interaction between bureaucrats and stakeholders during policy implementation process. 59 This model suggests that several factors need to be addressed when assessing the influences of stakeholders on implementation agency during regulatory rulemaking. Here three propositions are raised for empirical research. Proposition 1: Rulemaking output is conditioned by the discretionary range of an agency. This model argues that the allowed policy discretion of a governmental agency has significant impact on final rulemaking output, as denoted by the range of allowed discretion [θ L ,θ H ]. Agencies have discretion during regulatory policymaking process (Steunenberg, 1996). The discretion range may vary among agencies, policy issues and stages of policymaking. Wildavsky(1987) indicates that in democratic societies institutions are created to aggregate people’s diverse preferences. Yet, there is a large variety of institutional structures in any government system. Epstein and Halloran (1994) argue that agency discretion is used by various ex-ante and ex-post procedural constraints by the legislative body, and the level of discretion is also conditioned by policy issue and agency type. Thus, this raises a serious question of research design for empirical study on rulemaking or regulatory policymaking. Stated differently, a more generalizable empirical result should be drawn from more diversified setting with randomly selected sample of agencies, policy areas, and even national settings. Agency discretionary range may change from one agency (sub-agency) to another agency (sub-agency). For example, Federal Drug Administration’s discretionary range may be totally different from that of the Department of Transportation. Also, agency discretionary range may vary significantly among democratic and non-democratic countries. For example, in 60 societies where legislative control and public participation are not strong, governmental agencies may be the primary player of policymaking. Nevertheless, due to the difficulty of data collection, a large number of case studies may be necessary before a more general picture of agency rulemaking can be presented. This proposition also suggests that timing, or “policy windows”, does matter during agency rulemaking process. At different stages of policy development, a rule writer may have different levels of policy discretion. Moreover, when rulemaking activities take multiple stages, both rule writers and involved stakeholders face cost constraints that are not constant across all stages. In other words, an implementation agency may treat public comments/commenters differently during different stages of rulemaking. For example, a rule writer may be more attentive to external information at the beginning of rulemaking if she/he faces a high level of uncertainty then. Yet her/his responsiveness to external stakeholders may change over time, especially when a policy or program is already in place and any reverse action may incur substantial costs. Proposition 2: When participation cost increases, organized stakeholders will play more important role in rulemaking. This model argues that participation costs may constitute an important constraint for public involvement in policymaking and/or rulemaking. Participation cost is a major type of political transaction cost, and it is usually conditioned by political institutions, policy complexity, participation technology, bureaucratic responsiveness, and more. All of these constraints impact the level of political transaction costs in agency rulemaking processes. 61 This model suggests that more citizens will participate in the rulemaking activities if participation costs are low. For example, if public information is easily available and the process is transparent, more citizen participation can be observed. This has been identified by the increasing use of electronic rulemaking (Coglianese, 2004, Shulman, et al., 2003). Also, if the policy issue is not technically difficult, more people may be involved in the process of rulemaking. Stated differently, it will not be a surprising fact that in some policy areas citizen participations are minimal or even non-existent, while organized interest groups are very significant and active. Proposition 3: Comments from different stakeholders are weighted differently by the agency officials during rulemaking process. Finally, this model argues that the weight allocated to public comments may vary among comments and commenters, and the weight allocation is conditioned by political and technical reasons. Recent studies have identified that regulated parties or businesses are more capable to influence agency rulemaking (Yackee and Yackee, 2006, Jewell and Bero, 2007). Yet future research is still necessary to identify how rule writers allocate weight when they face hundreds or even thousands of public comments. In other words, more empirical evidence and more rigorous research design are needed to draw more generalizable conclusions. 3.5 Concluding Remarks Policy implementation is one of the most important steps in public policy process, and we have witnessed the theoretical and empirical studies by at least three generations of implementation scholars (deLeon and deLeon, 2002). Yet it is a 62 surprising fact that too many contingency theories of policy implementation have been developed and little formal modeling efforts have been devoted to understanding policy implementation. This paper provides a formal model of agency rulemaking by studying the role of political transaction costs in public policy implementation. It focuses on the interaction between implementation agency and involved stakeholders, a “multi-actor” approach originally proposed by O’Toole (1986). It argues that an agency will try to minimize the political transaction costs during policy implementation. This paper focuses primarily on the literature of transaction cost economics and environmental policy. However, it may have implications for research on general public policy and agency rulemaking. This paper is by no means the first one to provide a theory of policy implementation. Yet it may help implementation scholars better understand the dynamics of policy implementation. Compared with previous theories of policy implementation, this paper calls for more scholarly attention to a single variable: rule of policy implementation. This model suggests that the influence of public comments on agency rulemaking is conditioned by many internal and external factors: the discretionary range, participation costs, and the stage of rulemaking. For simplicity, this article only considers one-dimensional policy space. An expansion of this model to a multiple-dimension one should be meaningful for future empirical research on agency rulemaking. This will require a more sophisticated level of game theoretical modeling and dynamic analysis of the interactions between agencies and stakeholders. 63 Chapter 4 Stakeholders in Market-based Environmental Governance: Southern California’s Experiences with Rulemaking of Emissions Trading The past twenty years have witnessed the rise of market-based instruments in various environmental policy and management areas, such as municipal solid waste management (Menell, 2007, Miranda et al., 1994), greenhouse gas emission control (Christiansen and Wettestad, 2003), and acid rain reduction (Ellerman et al., 2000). This trend partially reflects the fact that traditional “command-and-control” approaches have not succeeded in effectively managing natural resources and protecting the environment, and thus the rise of market-based environmental governance also corresponds to the New Public Management Movement that calls for more market-based solutions for public problems (Freeman and Kolstad, 2007, Kettl, 2005). While there is a large body of literature talking about the theoretical advantages of market-based instruments over traditional command-and-control policies, relatively fewer empirical studies have been conducted on the implementation process of market-based policies. Specifically, we know very little about the role various stakeholders play during the regulatory design and policy implementation processes (Hahn and Stavins, 1992). In recent years, questions have been raised by environmental groups, businesses, and policy scholars, yet there are no definite answers to these intriguing questions, probably due to several facts: 1) market-based policy implementation is still a new topic for political scientists and 64 policy scholars; 2) the impacts of stakeholders on policy implementation are usually through informal/indirect processes, which are usually unobservable; and 3) even when formal processes are used, it is still difficult to measure these influences. This chapter attempts to address the gap in the existing literature by conducting a quantitative analysis on rulemaking of RECLAIM (Regional Clean Air Incentives Market), the first regional emission permits trading program in the world that has been implemented by SCAQMD (South Coast Air Quality Management District) in the Los Angeles air basin. This research treats rulemaking as the key process of policy implementation, and uses quantitative methods to examine the influence of stakeholder comments on RECLAIM’s rulemaking. The findings are summarized as follows: 1) organized stakeholder groups are dominant in submitting written comments to SCAQMD during the rule formation and revision stages of RECLAIM’s implementation rules; 2) the regulatory directions suggested by comments vary a lot among different stakeholders and also vary across different stages; 3) comments from governmental agencies, especially those from higher levels (California Air Resources Board and the U.S. EPA), are more likely to be accepted by SCAQMD; and 4) during rule revision stage, SCAQMD is more likely to adopt suggested rule amendments if a comment calls for a more market-oriented regulatory change. This research is among the first few studies that use quantitative methods to examine rulemaking activities within the special district context. These findings may contribute to the literature on environmental decision making and emissions trading. 65 This chapter consists of six sections. The first section introduces the background of RECLAIM and the implementation agency and rulemaking activities. The second section reviews the existing literature and introduces hypotheses. The third section describes data, model specification and methodology. The fourth section presents findings, followed by discussion and concluding remarks. 4.1 Background For decades, emissions trading has been supported by economists and policy scholars (Crocker, 1966, Dales, 1968, Tietenberg, 2006). The major mechanism used in emissions trading programs is cap-and-trade (CAT). With the cap decreasing every year, it is expected that market participants would have enough time to adjust to the new regulatory scheme, and trading will make environmental compliance more efficient and more effective compared with traditional command-and-control instruments (Freeman, 2002, Tietenberg, 2006). Yet only the past twenty years have witnessed the limited use of CAT at national level and international level, such as the U.S. Acid Rain Program, European Union Emission Trading Scheme (EU ETS), etc. Emissions trading programs at the local/metropolitan level, however, are less popular, largely due to the stricter requirements of regulatory/administrative capacity and the relatively limited market size. 4.1.1 Design and Implementation of Emissions Trading Program Even though some public policies are well-designed theoretically, they may end up with sub-optimal or even poor/unintended effects (Mazmanian and Sabatier, 1989). The implementation of emissions trading programs faces similar problems, and 66 it is more complex than what economic theory predicts. In recent years, it has been identified that the transaction costs associated with institutional transition and policy enforcement in emissions trading lead to less effective implementation (Foster and Hahn, 1995, Montero, 1997, Stavins, 1995, Woerdman, 2001), a fact that had been overlooked by economists and policy makers. It becomes increasingly clear that market-based instruments can bring a lot of challenges to governmental agencies in policy implementation, since the incentive structures and institutional constraints of market-based environmental policies are quite different from those of command-and-control instruments, and transaction costs associated with these issues may not be easily overcome (Woerdman, 2004). Both regulators and businesses have to face a lot of uncertainties when designing and implementing such a complex system. For example, Emission Reduction Market System (ERMS), Chicago’s regional emissions trading program for the reduction of volatile organic material (VOM), has encountered many unexpected problems during the implementation process, which include inappropriate initial goal setting, limited trading, and facility closure (Evans and Kruger, 2006). Chicago’s experience with emissions trading illustrates the uncertainties in the real world context and the difficulties in implementation. It is not surprising that carefully-designed emissions trading programs may end up with unsatisfactory outcomes. 4.1.2 The Case of RECLAIM: Implementation and Rulemaking Similar to Chicago’s ERMS program, Southern California’s Regional Clean Air Incentives Market (RECLAIM) is a regional air emissions trading program. As an 67 innovative policy instrument, RECLAIM has also suffered a lot of implementation difficulties since both SCAQMD and regulated industrial participants had to face many technological, regulatory and political uncertainties. Since its implementation in 1994, RECLAIM’s experience has illustrated both the difficulties of and the potentials for using market-based instruments to achieve public policy goals. The initial implementation of RECLAIM had witnessed a slow level of trading activities, which is partially explained by two economists that there are huge transaction costs at the beginning of an emission permits market (Foster and Hahn, 1995). Although major stakeholders had devoted great efforts to participate in the design of RECLAIM, the implementation plan has experienced numerous revisions during the implementation process, with inputs from businesses, environmental groups, state and federal agencies, and citizens. Nevertheless, there are still critiques about the effectiveness of RECLAIM. The original policy objective of RECLAIM was to achieve an ambitious goal of emission reduction by the end of 2003: 65% off the emission of sulfur dioxide and 83% off the emission of nitrogen oxides (Mazmanian, 1999). However, by the end of 2003, the total emission of sulfur dioxide from RECLAIM facilities was 46.7% off the 1994 level, and the total emission of nitrogen oxides from RECLAIM facilities was only 60.7% off the 1994 level (SCAQMD, 2005, p. 3-5). While these emission reductions are significant, the gap between the original goals and real outcomes implies imperfect policy implementation. The attention to the performance of RECLAIM has also raised several questions about the role of stakeholders. One of them is whether business groups have exerted overwhelming influence on the 68 implementation process. The formulation and implementation of RECLAIM rules have always come with conflicts, compromises and critiques. Numerous stakeholders had been trying to influence the design and revision of RELCAIM rules during last 15 years. One of the notable examples is that at the RECLAIM design stage, as a result of business lobbying, RECLAIM’s industrial participants were allocated more emission credits in 1994 than pollutants emitted in 1991. Another notable case of business influence was in 2000 when a sudden increase in demand for RECLAIM trading credits drove the prices of trading credits to an extremely high level. As a result of the California energy crisis, several executive orders from California Governor Gray Davis led to significant changes in RECLAIM rules, including the stabilization of prices of trading credits, a temporary exclusion of power plants from the RECLAIM market, and an increase in total cap of emission credits. In addition to these major changes, RECLAIM’s implementation has seen frequent amendments to its rules since 1995. Thus, it is not surprising that RECLAIM is facing the criticism that business groups have exerted an overwhelming influence during the implementation process (Drury et al., 1999). Meanwhile, several environmental groups, such as Coalition for Clean Air and Communities for a Better Environment have submitted many comments for imposing stricter enforcement for regulated facilities. RECLAIM’s implementation has shed light on the tension between stakeholders and governmental agency in market-based environmental governance. In the U.S., various stakeholders hold quite different positions on emissions trading, and existing studies have shown conflicting evidence. One survey conducted in 1997 shows that businesses, environmental groups and the electricity industry basically 69 prefer grandfathering permit trading schemes (Svendsen, 1999). However, even among environmental groups, some are very supportive of this new instrument, while a lot of them are not. For example, Environmental Defense, a long term advocate for emissions trading, has been working on promoting emissions trading in both the U.S. and worldwide. Yet numerous other environmental groups have been reluctant to support emissions trading, especially about the design and implementation of the market scheme. Some scholars argue that emissions trading provides an alternative access for environmental groups to participate in policy implementation process by purchasing emission credits (Carman, 2002). Yet in emissions trading markets, this strategy has been rarely, if not unseen, used by environmental groups. The impacts of different stakeholders on emissions trading implementation are still not well-understood, especially in the RECLAIM case, in which a special-purpose government is the major implementation agency. For example, it is alleged that under RECLAIM implementation rules, business “decides whether to reduce emissions or to use pollution credits” (Drury et al, 1999, p. 281). Some literature also indicates that environmental and public health groups are less influential during the policy formulation process of RECLAIM (Thompson, 2000). That being said, the role of stakeholders in market-based environmental governance is still controversial. To address the gap in the existing literature, this research conducts a case study on RECLAIM’s rulemaking activities, and it treats rulemaking as a part of policy implementation, an approach strongly endorsed by West (West, 2005). 70 4.2 Theory Stakeholder participation in democratic governance is not a new topic for public administration scholars. The U.S. has a long tradition of strong civil society organizations as well as other organized interest groups, all of which constitute the societal foundation of American democracy (Coleman, 1988, O’Connell, 1999, Putnam, 2000). The role of stakeholders in democratic governance, however, has been a more controversial issue in the existing literature, which has been dominated by two lines of arguments, namely the political economy tradition and the public administration tradition. 4.2.1 Stakeholders in Democratic Governance The relationship between stakeholders and government has been a central theme in the political economy literature. Economists have approached this question from the “capture” or “rent-seeking” perspectives, and they argue that organized interest groups can manipulate governmental agendas and produce regulations favorable to them (Becker, 1983, Buchanan et al., 1980, Peltzman, 1976, Stigler, 1971). While this line of literature provides a unique rational choice perspective to understand governments’ regulatory behavior, it still treats bureaucracy as a black box, with little attention to the institutions and their organizational decision making mechanism. Thus, the institutional process remains a black box. Indeed, as acknowledged by Peltzman (1989), “a full analysis of the scope and form of these institutions remains unwritten”. Laffont and Tirole (1991, page 1090) further criticize that both the Chicago and Virginia Schools have “methodological limitations” because 71 they ignore the information asymmetry between industry and regulator and ignore the “supply side” of regulations. Compared with economists, political scientists have a more active research agenda on bureaucratic institutions, the supply side of regulations. It has been well acknowledged that there are formal institutions that can exert control over the bureaucracy. For example, Congress usually uses administrative procedures to exert political control over bureaucracy during the policy implementation process (McCubbins, Noll, and Weingast, 1987, Ringquist et al., 2003). Political scientists have also extensively investigated the roles various interest groups play in the policymaking process, such as agenda setting, and issue definition, which have been well established in the theory of public policy process (Baumgartner and Leech, 1996, Wilson, 1980). Since special interest groups may impact public policy making at public expense, interest groups’ tendency to influence public policy is likely to be blamed (Lowery and Brasher, 2004). Yet public participation in policy making is also regarded as a method to address the “democracy deficit” in current political institutions (Halpin, 2006, p. 919). Scholars in public administration usually hold a more sympathetic attitude toward the role of public participation in democratic governance, and they have examined the collaborative role of stakeholders’ participation in public policy making and implementation. Environmental policy has been one of the areas with the highest level of public participation in American public life. Since the 1970’s, public administration scholars have attempted to explore the role of stakeholders in democratic governance from the perspective of environmental policy implementation, 72 a pivotal process that had been ignored by theory-oriented political scientists. Mazmanian and Sabatier (1989) indicate that public support, public attitudes, and resources of constituency groups are among the key variables that impact policy achievements throughout the implementation process. Buck (1984) also finds that higher public involvement in policy decision processes may lead to successful implementation. Yet public administration scholars also face a similar dilemma, and find that stakeholder participation in environmental governance may turn out to be “a double-edged sword” (Potoski and Prakash, 2004, p. 159). On the one hand, as one of the most contested policy areas, environment issues usually have a very high level of salience to the general public, and thus substantial stakeholder participation in the environmental policy process has become increasingly evident and necessary for effective policy making, regulatory compliance and the formation of collaborative governance (Durant, 2004, Koontz and Johnson, 2004, Leach, 2006). On the other hand, stakeholder participation may also provide opportunities for special interests to impede the implementation process (Potoski and Prakash, 2004). 4.2.2 Stakeholders and Agency Rulemaking Our limited understanding of the role stakeholders play in democratic governance may be partially attributed to the difficulty in measuring their influence on governmental agencies. In recent years, this difficulty has been addressed by a small group of scholars in the area of agency rulemaking (Furlong and Kerwin, 2005, Kerwin, 2003, West, 2005). Traditionally congressional lobbying has been regarded as the primary arena of interest groups influence on public policymaking (Furlong, 73 2007). Yet Kerwin (2003), one of the most important scholars in administrative rulemaking, indicates that public participation in rulemaking is a very important part of public policy implementation. Several scholars have conducted quantitative and qualitative research on rulemaking activities in federal and state agencies and yielded some interesting findings about organized stakeholders (Cuéllar, 2005, Furlong, 1997&1998, Golden, 1998, Jewell and Bero, 2007, Yackee, 2005, Yackee and Yackee, 2006). However, sometimes these findings are competing with each other in several important aspects, such as whether business groups are dominant in submitting comments, and whether organized interest groups can get their desired policy outcomes. Meanwhile, environmental policy scholars also attempt to understand the role of stakeholders in environmental rulemaking. For example, Furlong (2007) finds that similar to other policy areas, organized interest groups are major players of federal environmental rulemaking, and more specifically businesses “can play a pivotal role in shaping agency policy” (Furlong, 2007, p. 179). Yet Kamieniecki (2006, page 131) finds that business groups do not have significant influences on environmental agencies’ rulemaking outcomes. Existing studies have improved our understanding of the role stakeholders play in rulemaking, yet most of them primarily focus on rulemaking activities at the federal level (Yackee and Yackee, 2006), with no quantitative study that has systematically investigated the impacts of stakeholders on rulemaking at the special district level. Moreover, while extensive efforts have been devoted to this topic, our understanding of the role of stakeholders in democratic governance is still limited, partially due to the fact that public policy is not constant, which is driven by the shifting nature of policy 74 debate and the surrounding social, economic and political constraints of government and interest groups, as well as their complex interplay (Jones and Baumgartner, 2005). While recent years have witnessed the emergence of market-based governance in various policy areas, little attention has been devoted to the role of stakeholders in market-based policy implementation processes. Indeed, political scientists and public administration scholars still have not fully understood the process and dynamics within this new emerging governance structure, which has created both opportunities and constraints for stakeholders to influence governmental agencies in public policy processes. Southern California’s experiences with emissions trading illustrate the complex relationship between stakeholders and implementation agency in market-based governance. If the statement “all politics is local” is true, RECLAIM’s rulemaking can provide a unique opportunity to examine the influence of stakeholders on implementation of emissions trading and to explore how the interplay between regulators and stakeholders may have shaped the content of a market-based environmental policy. 4.2.3 Research Question and Hypotheses This research examines whether the organizational characteristics and regulatory direction of a comment impact SCAQMD’s response to public comments. The key research question is, does SCAQMD have a bias toward specific stakeholder(s) during RECLAIM’s rulemaking processes? Two hypotheses are developed. 75 Hypothesis 1: When various stakeholders are competing for influence on rule contents, comments from governmental agencies are more likely to be favored by SCAQMD. This hypothesis is derived from Proposition 3 in the previous chapter that argues that a rule writer may allocate different weights to different stakeholders. It is used to examine the agency’s responsiveness towards stakeholders during the rule formation stage and rule revision stage. 16 Stated differently, it is intended to examine whether a special-purpose government has different political interactions with different stakeholders, which is relevant to the “democratic performance” of special-purpose government (Skelcher, 2007, p. 62). While special-purpose governments have been increasingly used in policy implementation, we do not have fully understood their implications for democratic governance, such as inter-agency cooperation, public participation, etc. Since special-purpose governments usually have high level of technical expertise and policy discretion, it is quite natural to assume that special-purpose governments may be less subject to external influence by the general public. In the case of RECLAIM, SCAQMD’s Governing Board is consisted of local and state officials, and it has to be attentive to citizens, businesses, environmental groups, and local governments. However, SCAQMD can still maintain a high degree of independence. On the other hand, SCAQMD’s regulatory choices have also been constrained by the directions of California Air Resources Board and the U.S. EPA. For example, RECLAIM’s rule changes need final approval of the U.S. EPA. Therefore, it 16 RECLAIM’s rulemaking activities are divided into two stages: rule formation (before January, 1994) and rule revision (after January, 1994). 76 is natural to suspect that SCAQMD will allocate different weights to comments from different stakeholders. Yet there is a lack of systematic evidence supporting this argument. This hypothesis attempts to address this issue. Hypothesis 2: SCAQMD has no bias towards specific direction of regulatory changes proposed by comments. This hypothesis is derived from Proposition 1 in the previous chapter. This hypothesis is used to examine the agency’s attitude towards various directions of rule changes. Coglianese (2007) indicates environmental agency may lack important information for regulatory details during implementation. Since emissions trading program is innovative, SCAQMD had to face various political, legal, technical, and managerial uncertainties at the beginning of RECLAIM rulemaking, and it is also likely that the program would have to experience revisions towards stricter or looser requirements in many aspects, such as implementation flexibility and trading mechanisms, based on implementation experiences and external lobbying pressures. This research will also examine whether rulemaking within SCAQMD involves more organized interest group participation, compared with rulemaking activities within general governments. According to Proposition 2 raised in the previous chapter, when participation cost increases, organized stakeholders will play more important role in rulemaking. Since policy-dialogues related to emissions trading are highly technical and complex, ordinary citizens may not have enough information or knowledge to participate in the rulemaking process. I will analyze the percentage of comments from organized interest groups among all the comments submitted for 77 RECLAIM’s rulemaking, and then I will compare it with findings in the existing empirical research. 4.3 Testing the Hypotheses 4.3.1 Data RECLAIM’s implementation rules are called Regulation XX (Rule 2000 to Rule 2020, for details, see Appendix 2), which is a part of SCAQMD’s State Implementation Plan as mandated by the U.S. Clean Air Act. During the rule formation and revision processes, SCAQMD used public workshops and notice-and-comment procedures to collect public opinions. These methods are quite similar to those used by federal agencies in rulemaking, as mandated by the Administrative Procedure Act (Kerwin, 2003). This research uses data coded from RECLAIM’s rulemaking records, which are archived in SCAQMD’s library located in Diamond Bar, California. This library has maintained a comprehensive record of rulemaking activities for the RECLAIM program as well as other programs. Records of rulemaking activities include notices of proposed rulemaking/revisions, public hearing notices, public comments (oral and written comments), as well as SCAQMD’s responses and rule amendments. Comments come from various interest groups, including citizens, businesses, environmental groups, state and federal agencies. The author had visited the library for several times between January 2006 and April 2007 to make photocopies of these documents from the public records. Two datasets are created by random sampling. 78 The first dataset contains 127 issue comments that are randomly selected from the public comments during the rule formulation stage (1993). 25 letters from different stakeholders during the rule formation state of RECLAIM are identified, and 2/3 of them (18 letters) were randomly selected for this analysis. 17 Each comment letter contained several issues, and the SCAQMD made specific responses of whether they agree with this comment and whether to design the rule as suggested. The 18 letters include 512 issues, and I selected a stratified random sample of these issues for analysis 18 . 127 issues were finally selected for analysis, and thus the comment coverage rate is 24.9%. The second dataset contains 75 issue comments that are randomly selected from the rule revision stage (1994-2005). From 1994 to 2005, there are 74 rule revisions to Regulation XX (Figure 4.1). As far as the author identified, the rule revisions to Regulation XX had received a total of 33 written letters of public comments submitted by various stakeholders for RECLAIM’s rule revision between 1994 and 2005. There are also hundreds of oral comments conveyed and recorded during the public hearing/meeting activities, but these oral comments do not have any individual or organizational affiliation information. The 22 letters were randomly selected from the total sample of 17 Regarding the 2/3 principle, this number was an arbitrary decision. Since the comment letters of rule formation stage (before 1994) contains many more issue comments than those of the rule revision stage (512 v.s. 75), I further used a stratified random sampling method to collect 127 issue comments from the rule formation stage. 18 I used an online random number generator to get a random selection of numbers. The generator is located at: http://www.mdani.demon.co.uk/para/random.htm. The stratified random sample is selected in this way: for letters with less than 5 issues discussed, all issues were selected for analysis; for letters with more than 5 issues discussed, either 5 or 20% of the total issues will be selected whichever comes bigger. 79 33 letters (2/3 coverage). Due to the relatively few numbers of issues discussed, all the issues in these 22 letters were selected for analysis. Within the 22 letters, I identified 75 comment paragraphs that focus on specific issues and suggest rule changes. Figure 4. 1. Rule Revisions of RECLAIM RECLAIM Rule Changes 0 2 4 6 8 10 12 14 16 18 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Year Number of Rule Changes Source: Public Records Unit, South Coast Air Quality Management District. 4.3.2 Methods Content analysis was used to obtain quantitative information from the public comments. The method of comment analysis follows the methods used in previous quantitative research on rulemaking (Yackee, 2005, Yackee and Yackee, 2006). However, this research differs from previous studies in three ways. First, it focuses on a special-purpose governmental agency, which has different institutional and political constraints in comparison to federal agencies, the major focus of the existing rulemaking literature. Second, in suggested change analysis, regulatory change direction - a major variable used in previous studies on rulemaking - is further decomposed into three factors for the two stages. The three factors are: cap change, 80 market-orientation, and enforcement flexibility. Finally, this research treats stage as a major control variable, in addition to public salience and technical complexity. This strategy is used to capture not only political and technological variations but also the timing of rulemaking. SPSS was used to conduct a binary logistic regression to examine the influence of stakeholder comments on SCAQMD’s responses. Suggested change analysis Public comments on rulemaking usually call for specific changes in regulatory language. In the RECLAIM program, most of the comments focus on specific issues, and SCAQMD has to decide whether to adopt these suggestions. If the commenter calls for more governmental regulations, its regulatory direction will be coded as “1”. If the commenter calls for less governmental regulations, it will be coded as “-1”. If a comment has no specific regulatory direction, it will be coded as “0”. To capture the complexity of regulatory directions suggested by comments, regulatory direction is further decomposed into three dummy variables: “Goal” (cap change), “Enforcement” (enforcement flexibility)”, and “Market” (market-orientation). These three dimensions cover the major regulatory implications of public comments regarding the regulatory mechanism of emissions trading implementation. Bureaucratic response analysis For almost every oral and/or written comment, SCAQMD has responded with whether it would proceed to change the rule as suggested by the comment. Thus, SCAQMD’s response can be categorized into two types: 1) no change; 2) SCAQMD will go forward with the suggested changes. 81 4.3.3 Empirical Model Since the dependent variable is dichotomous, a binary logistic model is developed for this study. The empirical mode will be used to test whether being a specific type of organization or raising a specific regulatory change may increase the odds ratio of agency acceptance of a comment. Use P to denote the predicted probability of regulatory change, which is coded as “1” if the agency changes the rule or “0” if no rule change happens. The empirical model is written as: P is the predicted probability of agency acceptance of a public comment (coded as “1” if accepted, otherwise “0”). X is a vector of independent variables: organization type, regulatory directions suggested, and control variables. Dependent variables. During the rule formation stage, the dependent variable is regulatory response to each comment, and it is coded by using a dummy variable: “change”. If the agency makes a rule change or takes an action as requested by the commenter, it will be coded as “1”. Otherwise it will be coded as “0”. Predictor variables. This study uses two independent variables to predict SCAQMD’s response to public comments: “organization type” and “regulatory direction”. Organizational Type: For each comment issue, the organizational characteristics and the regulatory directions are coded by using a set of dummy variables: “NGO” (coded as “1” if an organization is a nonprofit organizations, X P P ODDS β α + = − = 1 ln ) ln( (4.1) 82 otherwise “0”), “BUS” (business groups or business interest representatives), or “GOV” (local or state or federal governmental agencies). Regulatory direction (REG): When discussing an issue, if the commenter calls for more governmental regulations, stricter enforcement or less flexibility, more ambitious emission reduction goal, its regulatory direction (REG) will be coded as “1”. If the commenter calls for less governmental regulations, loose enforcement or more flexibility, it will be coded as “-1”. If a comment has no specific regulatory direction, it will be coded as “0”. As introduced in previous section, three dummy variables are further used to describe the specific regulatory directions suggested by comments during rule revision stage. “Goal” will be coded as “1” if the comment calls for an increase of the cap, and “-1” if the comment calls for a decrease of the cap, and “0” otherwise; If the commenter calls for a more market-oriented change, such as less restrictions on inter-temporal or inter-regional trading, “Market” will be coded as “1”; if the commenter calls for a less market-oriented change, “Market” will be coded as “-1”; otherwise, “Market” will be coded as “0”; “Enforcement” will be coded as “1” if the comment calls for more enforcement flexibility, and “-1” if the comment calls for less enforcement flexibility, and “0” otherwise. Control variables. Three control variables are used to control the effects of public salience, issue complexity and timing of rulemaking. Dummy variable “salience” is created to identify whether a comment is also supported by other commenters during the same stage of rule revision; “complexity” is created to identify whether the commenter is addressing technological or regulatory uncertainties, and 83 “stage” is used to describe whether a comment was obtained from the rule formation stage or rule revision stage. A full description of the coding strategy is provided in Appendix 3. 4.4 Empirical Results 4.4.1 Who Participates in Rulemaking? Table 4.1 presents the percentages of different stakeholders in submitting the issue comments to SCAQMD. It is very clear that organized groups dominate in both the rule formation (100%) and rule revision stage (98.6%). This fact is consistent with findings in existing research (Golden, 1998). This fact confirms the presence of an active participation and dominant role of organized stakeholders in RECLAIM’s rulemaking. Table 4. 1 Stakeholder Types of Submitted Issue Comments Type Rule formation stage Rule revision stage Total (two stages) Number of Issues Percentage Number of Issues Percentage Number of Issues Percentage NGOs 44 34.6% 26 34.7% 70 34.7% Businesses 60 47.2% 26 34.7% 86 42.6% Government 23 18.1% 22 29.3% 45 22.3% Individual 0 0 1 1.3% 1 0.5% Total 127 100% 75 100% 202 100% 4.4.2 What Kind of Voices are Expressed? Table 4.2 presents regulatory directions suggested by comments, with means and standard deviations. NGOs, which include both environmental and public health groups, ask for more regulatory interventions in both rule formation and rule revision 84 stages. Business groups ask for less governmental regulations within the rules of RECLAIM. However, the voices of governmental agencies changed across stages. During the rule formation stage, they ask for less governmental regulations. During the rule revision stage, they tend to ask for more governmental regulations. Table 4. 2 Regulatory Directions Suggested by Comments Regulation directions suggested (REG) Rule formation stage Rule revision stage Total (two stages) NGO Mean (S.D.) 0.73 (0.544) 0.58 (0.578) 0.67 (0.557) No. of obs. 44 26 70 BUS Mean (S.D.) -0.28 (0.825) -0.65 (0.485) -0.40 (0.756) No. of obs. 60 26 86 GOV Mean (S.D.) -0.22 (0.795) 0.41 (0.796) 0.09 (0.848) No. of obs. 23 22 45 Specific regulatory changes suggested by comments during the rule revision stage: As shown in Table 4.3, directions of regulatory changes suggested by comments vary among different groups. Environmental groups tend to call for a reduced cap, less market-oriented changes and less enforcement flexibility for industries. Business groups tend to call for an enlarged cap and more enforcement flexibility. Governmental agencies tend to call for less market-oriented changes. However, governmental agencies call for more enforcement flexibility during the rule formation stage but less enforcement flexibility during the rule revision stage. 85 Table 4. 3 Regulatory Directions (Decomposed) Suggested by Comments Regulation implications Rule formation stage Mean (S.D.) Rule revision stage Mean (S.D.) Total (two stages) Mean (S.D.) NGO Goal -0.16 (0.37) -0.04 (0.196) -0.11 (0.320) Market -0.11 (0.321) -0.35 (0.629) -0.20 (0.469) Enforcement -0.27 (0.544) -0.69 (0.549) -0.43 (0.579) No. of obs. 44 26 70 BUS Goal 0.02 (0.129) 0.12 (0.431) 0.05 (0.262) Market 0 (0) -0.08 (0.272) -0.02 (0.152) Enforcement 0.25 (0.751) 0.38 (0.496) 0.29 (0.55) No. of obs. 60 26 86 GOV Goal 0 (0) -0.05 (0.213) -0.02 (0.149) Market -0.04 (0.367) -0.09 (0.294) -0.07 (0.330) Enforcement 0.39 (0.853) -0.41 (0.796) 0 (0.798) No. of obs. 23 22 45 4.4.3 Who is Favored by the Agency? Table 4.4 presents the relative influences of each type of organized group over other stakeholders. The relative influence model A1 finds statistically significant evidence suggesting that NGOs are relatively disfavored by SCAQMD. Comments from business groups are greatly disfavored. Comments from governmental agencies are favored by the agency in both stages. 86 Table 4. 4 Testing the Relative Influence of Stakeholders (Two Stages, Dependent Variable: “Change”) Independent Variables Model A1 (NGO) Model A2 (BUS) Model A3 (Gov) Organizational type NGO -1.048** (0.036) ---- ---- Business ---- -1.731*** (0.000) ---- Government ---- ---- 2.119*** (0.000) Regulatory direction 0.213 (0.375) -0.453* (0.067) -0.030 (0.898) Control variables Complexity -0.154 (0.72) 0.249 (0.578) -0.122 (0.795) Salience -0.054 (0.922) -0.389 (0.476) -0.105 (0.857) Stage -0.345 (0.386) -0.408 (0.315) -0.714 (0.113) Constant -1.001 (0.002) -0.706 (0.028) 01.858 (0.000) Sample size 202 202 202 -2 Log Likelihood 189.683 179.764 167.065 Percentage of correct observations 81.2% 81.2% 83.7% Notes: Coefficients are in bold, with P value in parentheses. *** denotes p<0.01 ** denotes p<0.05 *denotes p<0.1 4.4.4 What Kinds of Regulatory Suggestions are Favored? Table 4.5 presents impacts of comments on SCAQMD’s rulemaking. I use three models (B1, B2 and B3) to examine the relative influences of specific stakeholder. I found that only comments from governmental agencies are more likely to lead to changes in RECLAIM rules (p=0.000). There are no statistically significant signs that comments from either NGOs or business are more likely to result in a rule change. Moreover, two models (B2 and B3) find that comments calling for more market-oriented changes are more likely to result in a rule change. 87 In sum, this analysis also finds that the relative influence of governmental comments decreases during the rule revision stage (or after the RECLAIM was implemented). The results show that SCAQMD has allocated different weights to comments from different stakeholders during the rulemaking process. Table 4. 5 Testing the Relative Influence of Stakeholders on Specific Directions (Two Stages, Dependent Variable: “Change”) Independent Variables Model B1 (NGO) Model B2 (BUS) Model B3 (Gov) Organizational type NGO -0.904** (0.066) ---- ---- BUS ---- -1.733*** (0.000) ---- Gov ---- ---- 2.200*** (0.000) Market implications Goal 0.120 (0.873) 1.214 (0.143) 0.755 (0.390) Market 0.984 (0.157) 1.063* (0.080) 1.249* (0.097) Enforcement -0.268 (0.372) 0.304 (0.300) -0.173 (0.563) Control variables Complexity -0.191 (0.659) 0.244 (0.591) -0.237 (0.623) Salience -0.094 (0.866) -0.283 (0.615) -0.108 (0.856) Stage -0.387 (0.351) -0.344 (0.425) -0.835* (0.086) Constant -0.956 (0.003) -0.697 (0.030) -1.756 (0.000) Sample size 202 202 202 -2 Log Likelihood 187.447 175.874 162.972 Percentage of correct observations 81.2% 82.2% 83.7% Source: Coded data from rule-making records collected from the SCAQMD library. Notes: P value is included in parentheses. *** denotes p<0.01 ** denotes p<0.05 * denotes p<0.1 4.5 Discussion This research has several intriguing findings. First, rulemaking within the special-purpose government has been dominated by organized interest groups, namely 88 businesses, environmental groups, and governmental agencies from local, state and federal levels. It seems that individual citizen participation does not happen a lot in this process. Second, the agency has bias towards different groups. While comments from governmental agencies are more likely to lead to rule changes or agency actions in rulemaking, comments from businesses and NGOs are relatively disfavored. Stated differently, this special-purpose government is not easily captured by either businesses or NGOs. Third, as suggested by the sign and significance of variable “Market” in Model B2 and B3, it seems that SCAQMD was attentive to market-oriented suggestions. Finally, the sign of “Stage” suggests that SCAQMD was less likely to change the rules during the rule revision stage. The second finding is especially intriguing. The allegation (Drury et al., 1999) that businesses are favored by SCAQMD is not supported by this research. Unlike previous studies on rulemaking (Yackee and Yackee, 2006), this research fails to identify that regulators have a favorable bias towards business groups during rulemaking, an argument strongly supported by traditional capture theory. This research also confirms Thompson’s finding that environmental groups are not favored by SCAQMD (Thompson, 2000). This research concurs with Kamieniecki’s finding that environmental agency has not been significantly impacted by business groups during the rulemaking process (Kamieniecki, 2006). Also, as suggested by the third empirical finding, when there are conflicts between democratic principle and market principle, this implementation agency has chosen to defend the market principle, which is the foundation of emissions trading systems. This is a fact that economists may want to applaud. 89 Moreover, the interaction dynamics between SCAQMD and its stakeholders seems to be quite different before and after the RECLAIM is formally enacted. Does the agency face quite different political and policy environment between the two stages? The answer might be “Yes”. The fourth finding implies that the nature and level of political resistance during rule formation stage might be different from that in the rule revision stage when implementation is already initiated. A similar argument was raised by James Q. Wilson and later interpreted by Avinash K. Dixit: Agencies accept innovations that improve their ability to perform the existing and accepted tasks, but changing the tasks in any significant way, or reducing the autonomy of the agency in carrying them out, is fiercely resisted (Dixit, 1996, p. 25). In this case, SCAQMD’s responses to public comments are consistent with Dixit’s argument. Yet its implication may need future empirical investigation. On the other hand, we can also get some clues from the creation of the U.S. EPA. As argued by Alfred Marcus: The creation of the Environmental Protection Agency (EPA) in 1970 and the passage shortly thereafter of statutes giving the new agency broad powers to reduce pollution were political moves informed by a theory of how to best prevent a regulatory agency from being ‘captured’ by industry of affiliated with bureaucratic sloth (Marcus, 1980, p. 267). SCAQMD’s role in RECLAIM rulemaking illustrates that Marcus’s argument may also be applied to local environmental agencies, especially to special-purpose governmental agencies. As a non-elected governmental agency with substantial special knowledge in emissions trading as well as a strict policy goal of emission control, SCAQMD has to rely more on their own expertise and to be tough on the general public during the rulemaking process. This raises an interesting question about 90 the role of expertise in policy making (Batten et al., 2006). The second finding may also be relevant to the lobbyist role of public agencies (Deshazo and Freeman, 2005). Compared with general-purpose government, special-purpose government is less controlled by the general public. Yet the existence of “interagency lobbing” (Deshazo and Freeman, 2005), which includes substantial dialogues and interactions between the special-purpose government and other governmental agencies, such as local governments, state and federal governments, may constitute some extent of administrative control over bureaucratic discretion in rulemaking, as observed in this research. In this case, one major reason for the strong administrative control or inter-agency lobbying lies in the fact that RECLAIM, as a part of State Implementation Plan, needs the final approval from higher level governmental agencies. Yet, to what extent should and could the implementing agency of an emissions trading program be persistent to its own mission of environmental protection, rely on its own expertise, and be immune from impacts of the general public? We do not yet have answers to these questions. 4.6 Concluding Remarks For decades the role that stakeholders play in democratic governance has been a key arena of scholarly inquiry. Scholars of public administration and environmental policy have attempted to understand this issue from different perspectives. Yet little has been written on the role of stakeholders in market-based environmental governance. The rise of market-based policy instruments in modern governance has 91 been driven by their theoretical advantages in efficiency and effectiveness. However, the implementation of market-based instruments is also constrained by democratic principles. When market-based instruments are increasingly used now, understanding whether and how stakeholders impact the policy implementation process has important implications for both scholars and practitioners of public administration. This research examines the impacts of public comments on rulemaking of an emissions trading program, and reveals that governmental agencies, rather than businesses or environmental groups, have significant impacts on rulemaking of an emissions trading program. Stated differently, the public lacks control over the implementation agency of emissions trading. The RECLAIM case illustrates that the conflict between expertise and politics continues to be a key dilemma for public even within a special-purpose government. As we know, public administration has been struggling with the tension between democratic politics and professional expertise. The RECLAIM case raises a question about how to balance democratic decision making and bureaucratic expertise during policy implementation within special-purpose governments. 92 Chapter 5 Rules and Effects: An Evaluation of the Implementation of RECLAIM 5.1 Introduction Advocates of market-based environmental policy instruments argue that MBIs can achieve cost-effectiveness, reduce implementation costs, and encourage technological innovation (Freeman, 2002, Freeman and Kolstad, 2007). Along with the implementation of cap-and-trade (CAT) emissions trading systems, the recent years have witnessed remarkable reductions of emissions of both NO x and SO 2 in the U.S. (EPA, 2004). Empirical studies conducted in different national and regional contexts have confirmed the effectiveness of emissions trading systems. For example, Kamieniecki et al. (1999) argue that RECLAIM has been fairly effective in emissions reduction compared with CAC instruments in the context of a rebounding economy between 1993 and 1996. Several other evaluation studies on RECLIAM also contend that RECLAIM is effective (Ellerman, 2003, EPA, 2004, Harrison, 2005). O’Ryan also confirms the cost-effectiveness of a regional emissions trading system in Santiago, Chile (O’Ryan, 1996). However, the effects of emissions trading systems are still subject to criticisms (Drury et al., 1999, Stavins, 1995). Specifically, a major controversy is whether the adoption of emissions trading systems has really resulted in the reduction of air pollutants. Greenstone (2004, p. 609) argues that while there has been an 80% decline in the emission level of SO 2 in the U.S. over the last 30 years, “the cause of the dramatic reduction in ambient SO 2 remains a mystery”. More specifically, Greenstone (2004) finds that the hypothesis 93 that Clean Air Act Amendments (CAAA) has no impact on this reduction cannot be rejected (Greenstone, 2004). Greenstone uses the concentration level of SO 2 and non-attainment designations to examine the effects of CAAA. Although the two sets of data are different, the policy implication of Greenstone’s research is significant because his research greatly challenges the validity of CAAA’s policy effects. Since the enactment of CAAA initiated a huge regulatory change from CAC instruments to MBIs, the argument that MBIs are more effective than CAC instruments in emission reduction is open to question. Moreover, whether the adoption of emissions trading has led to technological innovation and environmental efficiency is also open to question. Driesen (2007, p. 441) indicates that “high costs encourage innovation, low costs discourage it”. Thus, Driesen argues that theoretically emissions trading “does a poorer job” of stimulating technology innovation and there is no “convincing empirical evidence that trading fosters innovation better” (Driesen, 2007, p. 436). Driesen (2007) further argues that policymakers should pay more attention to the design of emissions trading programs so as to provide stronger economic incentives for technological innovation. Recent literature has identified that inadequate design may cause unsatisfactory performance of emissions trading systems, especially during the initial stages of implementation (Foster et al., 1995). Huge transaction costs induced by inadequate policy design and implementation can impede permit trading. A loose cap may lead to low prices of emission permits, which may cause the lack of strong incentives for technological innovation and active trading. Thus, inadequate design may reduce both the efficiency and effectiveness of market-based instruments (MBIs) (Foster et al., 94 1995). One major explanation is that regulators and stakeholders may have faced uncertainties when designing the market. For example, Stavins (1996) indicates that policy makers face a lot of uncertainties about costs and goals when they are making an instrument choice. Thus, it is quite possible that emissions trading system was selected only because it could lower uncertainties in environmental outcome and policy goals. On the other hand, Stavins (1995, p. 133) indicates that the claims of cost-effectiveness of emissions trading systems “have often exceeded what can reasonably be anticipated”, and there have been concerns that emissions trading systems will create pollution “hot spots” in some areas (Stavins, 1998). Fullerton et al. (1997, p32) also find that compared with command-and-control regulation, emissions trading system “could more than double the cost of sulfur dioxide compliance” when utilities are also regulated by state public utility commissions. A major problem with the methodology used in the existing literature is that existing studies focus only on the overall reduction of emission in one area, regardless of the underlying dynamics of emission change. For example, how do rules impact emissions trading? Is emission reduction primarily driven by changes in economic structure, population change or regulatory policies? Were similar emission reductions happening in other areas where CAC instruments were used during that period? There are no definite answers to these critical questions. Don Fullerton is among the few economists who has developed a framework to compare major approaches in environmental policies (Fullerton, 2001). However, the major focus of this framework is efficiency and distributional effects, and the effects of policy instruments are ignored. It seems that most scholars assume that MBIs are at least as effective as 95 CACs, an assumption that may be wrong. Stated differently, the cost-effectiveness of emissions trading is not self-evident. Theoretically the logic behind cap-and-trade is quite straightforward (Atkinson and Tietenberg, 1987), and cap-and-trade systems can produce efficient and effective environmental outcomes if there are no transaction costs. In an ideal setting, permits are treated as property; the allocation of permits is through auction; inter-temporal and inter-regional trading should be allowed; compliance and monitoring costs are low. However, the implementation rules and processes can be very complex for various political and administrative reasons. Thus, it is unclear whether the rules of an environmental market are able to create strong incentives for participants to actively reduce emissions or trade permits so as to produce the most efficient and effective environmental outcomes. While presumably the environmental effectiveness of cap-and-trade emissions trading should be the same as, if not better than, traditional command-and-control instruments (Crocker, 1966, Dales, 1968, Ellerman, 2003), in practice it is always difficult to compare the effectiveness of emissions trading programs with command-and-control regulations because we do not know what would have happened if no emissions trading program has been implemented in a place. In recent years, scholars have raised questions regarding the effectiveness issue (Drury et al., 1999, Stavins, 1995). Is market-based environmental governance more effective than traditional command-and-control regulations? How do implementation rules and processes relate to the effects of emissions trading? There are still doubts from environmental groups, businesses and even policy makers, and answers to these 96 questions are important for both policy makers and citizens who have serious concerns about future environmental policy making and implementation. This chapter is intended to analyze the relation between rules and effects of emissions trading. Firstly, I conduct a qualitative analysis of the implementation rules and effects of RECLAIM. Secondly, this research applies ordinary least squares (OLS) regression analysis to test the null hypothesis that using emissions trading, compared with using CAC, has no effects on emission change when county factors and time factors are controlled. This chapter concludes that: 1) the market structure of RECLAIM has been distorted in many aspects compared with a pure free market; and 2) RECLAIM has helped emission reductions in the Los Angeles air basin, yet its effectiveness is not more or less than traditional command-and-control instruments. In other words, while RECLAIM is a distorted market, it still works. 5.2 Rules of Emissions Trading: The RECLAIM Case Emissions trading systems are built on market mechanism; yet the market is constructed by many rules governing mechanisms of permits allocation, permits trading, compliance enforcement and record tracking. However, while economists propose a straightforward model of cap-and-trade, more design parameters and implementation rules are left to implementation agencies. A recent report conducted by SCAQMD states that: Once the cap-and-trade program rules were adopted, the rule development process was far from being finished. Many rule amendments have been necessary to make the program clearer, more enforceable, more flexible, and to reflect the evolution of market participants and types of trades. In addition, standardized implementation guidelines needed to be developed for all aspects of the program. (SCAQMD, 2007, III-1-4) 97 Since implementation officials are constrained by information asymmetry, the rules of an emissions trading system may not be able to produce the optimal outcome; and even when rules are well-designed, agency officials are also subject to political pressure or interventions from other governmental agencies or powerful stakeholders, which may force them to break their original commitment of emissions reduction. Public hearings, notice-and-comment rulemaking, stakeholder meetings and other approaches have been used to design the implementation rules of RECLAIM. As analyzed in a previous chapter stakeholders’ participation in rulemaking influences the rule formation and revision of RECLAIM. 5.2.1 Stakeholders and RECLAIM’s Rulemaking Agency rulemaking is a major process through which an implementation agency collects public opinion, technical information and other details that may not be available to agency officials otherwise. During this process, stakeholders or interest groups may lobby administrative agencies and even decide how implementation rules of an environmental policy are applied to individual cases (Kamieniecki, 2006, Lehne, 2001, see also Kraft and Kamieniecki, 2007). Agency officials face stakeholders representing different or even competing interests over multiple issues, and sometimes they have to compromise to ensure a consensus. Therefore, an ideal emissions trading market may not be fully implemented due to political and administrative difficulties. Earlier research conducted by Atkinson and Tietenberg (1987) finds that trading rules of the US EPA’s experiment with emissions trading have to be adjusted to accommodate political and administrative feasibility, due to the fact that transaction 98 costs are very high and the political risk of “hot spots” is not acceptable. Thompson (2000) indicates that RECLAIM faces numerous technical and regulatory uncertainties and a lot of political obstacles during the implementation process, such as the overwhelming impacts of businesses. Lobbying is also intense during the design and implementation of RECLAIM. As a special-purpose government, SCAQMD may have more leverage to reduce the influence by external lobbying. In fact, SCAQMD was very ambitious and successful in designing and implementing various policies/programs to improve air quality in the Los Angeles air basin during the 1970s and 1980s. However, in the early 1990s SCAQMD still faced the difficulty of using command-and-control instruments to achieve the emission reduction goal mandated by the federal CAAA. It was under this circumstance that SCAQMD adopted a cap-and-trade emissions trading system, and it had to promise to avoid deadlocks or political and administrative resistances. 5.2.2 Rules of RECLAIM RECLAIM rules manage allocation of permits, new resource review, mechanisms of trading, monitoring, and recording; and plans of compliance and sanction. 19 In the RECLAIM program, the trading permit is called “RECLAIM Trade Credits” (RTCs). They were originally allocated to industrial participants in 1994 and then used and traded by these participants, with the total cap of RTCs decreasing year by year. Yet the implementation rules of RECLAIM are more complex than a simple 19 Details of the RECLAIM rules are available at the SCAQMD website: http://www.aqmd.gov/rules/reg/reg20_tofc.html. 99 “cap-and-trade” model, and many features impose stringent restrictions on trading, which cause market distortions in RECLAIM. As analyzed in previous chapters, stakeholders who have participated in RECLAIM’s rulemaking can be divided into three categories: businesses, environmental and public health groups, and governments. Different stakeholders have different concerns over parameters of the program. To make the RECLAIM politically acceptable and administratively implementable, SCAQMD has made many compromises and revised the program in many aspects since the discussion of this program. For example, the allocation of RTCs is based on the principle of “Grandfathering”, which is less efficient than auction mechanisms. Due to “hot time spot” and “hot zone” concerns of governmental agencies and environmental groups, strict restrictions on inter-temporal trading and inter-regional trading were adopted. Due to job loss concerns from local governments and concerns of compliance costs, small business and facilities were excluded from the program. Moreover, since the prices of RTCs skyrocketed during the 2000 “energy crisis”, some backstop provisions were added into the RECLAIM rules to establish a price intervention mechanism if the prices of RTCs reach a certain level. In recent years, increasing attention has been paid to the political obstacles to implementation of emissions trading (Joskow and Schmalensee, 1998, Thompson, 2000), and some studies have identified the impacts of inadequate rules on market outcomes. For example, Zhang (2008) finds that inter-temporal trading and banking may reduce uncertainty in emissions trading markets. Grandfathering is usually regarded as a less efficient mechanism of resources allocation in comparison with 100 auction. Since the design parameters of RECLAIM vary from an ideal cap-and-trade program, an intuitive question will be: do market distortions impact RECLAIM’s performance? There still lacks a systematic study to examine the impacts of rule difference on policy outcomes, and the underlying dynamics of emission change and the effectiveness of policy instruments are not well understood yet. Indeed, the issue of comparing policy effectiveness of emissions trading in different rule arrangements is a very controversial one and not yet sufficiently researched by scholars. The lack of empirical evidence limits the validity of arguments either supporting or opposing the effectiveness of emissions trading. In this chapter, I attempt to analyze the relationship between rules and effectiveness of emissions trading from both qualitative and quantitative approaches. 5.3. A Qualitative Assessment of the Effects of RECLAIM Rules This section uses a qualitative approach to identify the factors that have facilitated or impeded the effective implementation of RECLAIM. Data and information were obtained through both literature review and stakeholder survey. I have reviewed various materials on the implementation process of the RECLAIM program, including governmental documents, academic articles, and independent reports from environmental NGOs. Another major source of information is the surveys I conducted with four NGO staff and three governmental officials from EPA and the SCAQMD. Key questions asked in this survey include: 1) RECLAIM’s effectiveness; 101 2) the factors that have influenced the trading activity and the implementation of RECLAIM, and 3) how to overcome these barriers. 20 5.3.1 Rules and Incentives for Emissions Trading Rules structure the behaviors of regulated business. Foster et al. (1995) find that high transaction costs induced by complex regulatory rules had impeded the trading activity in the RECLAIM program. For example, an evaluation conducted by the U.S. EPA finds that some industrial participants did not fully understand the rationale of trading, and they don’t even know they could sell extra emission credits (EPA, 2002, p. 21). This is true for middle and small companies who usually lack the capacity or willingness to actively participate in the emissions trading 21 . In recent years, the rules of RECLAIM have been amended to provide more incentives for emissions trading. However, there still exist some barriers for active trading. First of all, the property right arrangement of RECLAIM is incomplete. One SCAQMD officer indicates that RECLAIM Trade Credits (RTCs) are not defined as property rights for administrative/implementation flexibility, and “if RTCs are property rights, government cannot take them from business”. 22 One recent report of SCAQMD admits that “When RECLAIM was developed, the District staff carefully constructed the rules to make sure that RTCs were not property rights (SCAQMD, 2007, III-1-5), and “to preserve flexibility to amend the program, credits should not constitute property rights (SCAQMD, 2007, III-1-7). Due to the concern of 20 A detailed description of the questionnaire for participants can be found in Appendix 4. 21 Interviewee from ENVIRON International Corporation. 22 Interviewee from SCAQMD. 102 administrative flexibility, an SCAQMD officer indicates that SCAQMD has no plan to treat RTCs as property rights in future rule revision. 23 While the property right arrangement of RECLAIM is incomplete, there was an excessive initial allocation of RTCs. Both environmental stakeholders and regulated business groups of the RECLAIM program agreed that “the initial allocation of RTCs was too high”, and it affected the performance in the market (EPA, 2002, p. 44). For example, an environmentalist interviewee argued that “politics and a system that starts out with a sea of excess credits” 24 are the major barriers for active trading. It was also found that before 1999, most industrial participants had an “excess number of RTC credits because of the initial allocation” (EPA, 2002, p. 23). Even though the cap is falling year by year, the allocated RTCs have been relatively excessive. As shown in Tables 5.1, 5.2, Figures 5.1, 5.2, for most time in the implementation process, the allocated RTCs were much higher than what have been emitted. From the standpoint of economics, an excessive allocation may lead to low prices and an inefficient use of RTCs. The initial over-allocation of RTCs was partially based on the SCAQMD’s belief that it would “allow participants to gain familiarity with the program’s structure and market behavior” (EPA, 2002, p.44). In other words, an excessive initial allocation of RTCs made RECLAIM more politically acceptable to regulated businesses. Due to the fact that participation in the RECLAIM may incur significant start-up costs and technological requirements, an official of 23 Interviewee from SCAQMD. 24 Interviewee from Coalition for Clean Air. 103 SCAQMD indicated RECLAIM could not have been adopted if there were no over-allocation of RTCs. 25 Table 5. 1 Annual Permit Allocations and Real Emissions of NO x (1994 – 2006) Annual NO x Emissions (tons) % Change from 1994 Total NO x RTCs (tons) NO x RTCs Left Over (tons) NO x RTCs Left Over (%) 1994 25,314 0.0% 40,127 14,813 37% 1995 25,764 1.8% 36,031 10,267 28% 1996 24,796 -2.0% 32,017 7,221 23% 1997 21,786 -13.9% 27,919 6,133 22% 1998 20,982 -17.1% 24,678 3,696 15% 1999 20,775 -17.9% 21,013 238 1.1% 2000 20,491 -19.1% 17,197 -3,294 -19% 2001 15,721 -37.9% 15,693 -28 -0.18% 2002 10,943 -56.8% 14,044 3,101 22% 2003 9,942 -60.7% 12,484 2,542 20% 2004 9,953 -60.7% 12,477 2,524 20% 2005 9,556 -62.3% 12,484 2,928 23% 2006 9,166 -63.8% 12,487 3,321 27% Source of Data: This table is quoted directly from SCAQMD (2008), Annual RECLAIM Audit Report for the 2006 Compliance Year, March 7, 2008. Figure 5. 1. Permit Allocations and Real Emissions of NO x (1994 – 2006) NOx (1994 – 2006) 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year Em issions Annual Emissions Allocation of RTCs 25 Global Warming Emissions Cap and Trade Program Forum --the RECLAIM Example, April 26, 2007, Diamond Bar, CA. 104 Table 5. 2 Annual Permit Allocations and Real Emissions of SOx (1994 – 2006) Annual SO x Emissions (tons) % Change from 1994 Total SO x RTCs (tons) SO x RTCs Left Over (tons) SO x RTCs Left Over (%) 1994 7,232 0.0% 10,365 3,133 30% 1995 8,064 +11.5% 9,612 1,548 16% 1996 6,484 -10.3% 8,894 2,410 27% 1997 6,464 -10.6% 8,169 1,705 21% 1998 6,793 -6.1% 7,577 784 10% 1999 6,378 -11.8% 6,911 533 8% 2000 6,009 -16.9% 6,185 176 3% 2001 5,003 -30.8% 5,557 554 10% 2002 4,374 -39.5% 4,924 550 11% 2003 3,855 -46.7% 4,292 437 10% 2004 3,580 -50.5% 4,292 712 17% 2005 3,621 -49.9% 4,292 671 16% 2006 3,580 -50.5% 4,282 702 16% Source of Data: This table is quoted directly from SCAQMD (2008), Annual RECLAIM Audit Report for the 2006 Compliance Year, March 7, 2008. Figure 5. 2. Permit Allocations and Real Emissions of SOx (1994 – 2006) SOx (1994 – 2006) 0 2,000 4,000 6,000 8,000 10,000 12,000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year E m ission s Annual Emissions Allocation of RTCs 105 The excessive initial allocation of RTCs also contributed to the low prices of RTCs. Since the implementation of the RECLAIM, the prices of RTCs have been low for most part of this period. It was found that “most large companies attempt to weigh the price of the credits and the marginal cost of compliance to determine whether they should install control technology or purchase additional credits” (EPA, 2002, p. 18). When the price of RTCs is low, it cannot provide a strong incentive for the industrial participants to actively participate in either trading activations or adopt new technology of emission reduction. The potential suppliers who have extra RTCs do not want to sell as many of them as possible because emissions trading is not their major business and cannot bring a lot of money, or they may worry about the loss of their public reputation as a seller of pollution credits. Meanwhile, since generating profit from emissions trading is not the main goal of industrial participants, they may choose not to sell unused RTCs if they are in compliance status (EPA, 2002, p. 21). The potential buyers are less likely to make technological innovation to reduce their emission level because they can buy RTCs at low prices. A long period of low prices of RTCs does not necessarily mean that the low prices will exist forever. However, the wrong belief and long indulgence in low prices resulted in an extreme price strike in 2000, when the demand suddenly increased and the supply didn’t change. Thus, the RECLAIM market collapsed and the politics worked. On the other hand, rules of RECLAIM did not provide strong incentives for technological innovation for emission reduction. For example, the average cost of best available control technology for NO x was about fifty times of the average price of emission credit of NO x in the early period of the implementation of the RECLAIM 106 program (Drury et al, 1999, p. 277). When the price spike happened in 2000, the business sector successfully lobbied the government to stabilize the price and increase the cap. After the stabilization of the price of RTCs of NO x , the industrial participants do not need to worry about a new price spike. Therefore, the primary choice for most industrial participants would be buying cheap RTCs rather than adopting new technology or innovation. Moreover, SCAQMD did not have an emergency plan for skyrocketed prices of RTCS during the initial rulemaking of RECLAIM. 26 Market manipulation might also mislead trading activities. An environmental NGO official said that “they (emissions trading programs) are ripe for fraud and manipulation” 27 . It was found that the market of emissions trading may be manipulated by industrial participants or brokers, who provide misinformation to create inadequate perceptions on demand, supply and RTC prices (EPA, 2002, p. 19). 5.3.2 The Marginalization of NGOs Environmental governance involves multiple stakeholders; yet the roles of stakeholders vary a lot during the implementation of RECLAIM. Traditionally, citizen participation has been a critical part of environmental regulation (Laurian, 2004). As major stakeholders of the RECLAIM program, communities and environmental groups have open accesses, such as public hearing, notice-and-comment rulemaking, to participate in the design and revision of 26 Global Warming Emissions Cap and Trade Program Forum --the RECLAIM Example, April 26, 2007, Diamond Bar, CA. 27 Interviewee from California Environmental Rights Alliance. 107 RECLAIM program. In the implementation process of the RECLAIM program, however, the role of citizen participation has been marginalized to some extent. The regulatory transition from command-and-control framework to market-based governance has greatly changed the interactions between SCAQMD and environmental NGOs, especially those environmental justice groups. As shown in chapter 4, individual citizens have rarely participated in the rulemaking of RECLAIM. Moreover, voices from environmental NGOs did not have a good chance to be accepted by SCAQMD officials. It is not a surprise that the effectiveness of RECLAIM has been doubted by the NGO sector, and the relationship between the environmental NGOs and the SCAQMD is moving toward a confrontational one rather than a collaborative one. A series of lawsuits filed by environmental NGOs against the SCAQMD in the recent years have proved this trend. Stakeholders from environmental NGOs argue that the RECLAIM program failed to achieve the goal of emission reduction. For example, one interviewee said that “I do not support trading programs, and they can have adverse environmental justice impacts by allowing the concentration of pollution sources in impacted communities” 28 . Moreover, stakeholders from NGOs strongly support the command-and-control instruments. As one of the interviewees indicated, “there would have been more emission reductions if AQMD had stuck to its ‘command-and-control’ approach”. 29 . One of the interviewees also indicated that “some industrial participants are asking to return to command-and-control by arguing that they cannot compete with other regions of the 28 Interviewee from California Environmental Rights Alliance. 29 Interviewee from California Environmental Rights Alliance. 108 state or nation because RECLAIM is too tough” 30 . Drury et al. (1999) criticize that under the rule of the RECLAIM program, the industrial participant “decides whether to reduce emissions or to use pollution credits” (Drury et al, 1999, p. 281), and they argue that citizens who are negatively influenced by the emissions traded into their communities can do little because the industry has the “right” of emission (RTCs), and it is more difficult for communities to monitor the emission activities of the industrial facilities in market-based environmental governance (Drury et al., 1999). Therefore, technological innovation may be difficult if industrial participants are sensitive to neither prices nor public pressures. The lack of citizen participation in RECLAIM may have reduced the legitimacy of RECLAIM. Since conceptually emission credits are not defined as private goods but “public bads”, the involvement of citizen participation may be necessary for a more democratic process of implementation, which may ensure both environmental justice and effectiveness. However, one senior official of SCAQMD admits that the radical position of NGOs usually “leaves no room for negotiations”. 31 In contrast to the position of some environmental NGOs, EPA, California Air Resources Board, and SCAQMD continue to support the implementation of RECLAIM. They believe that RECLAIM has really improved air quality. For example, the Annual RECLAIM Audit Report for the 2002 Compliance Year of the SCAQMD stated that “there is no toxic impact due to the implementation of the RECLAIM program” (SCAQMD, 2004, p. 5). 30 Interviewee from Coalition For Clean Air. 31 Interviewee from SCAQMD. 109 While theoretically a well-functioning emissions trading system can create strong incentives for technological innovation, permits saving, and active trading, in reality key stakeholders may impact the design and the performance of emissions trading. RECLAIM’s experiences have highlighted the vulnerability of environmental market to interest group politics. When the prices of RTCs are low, the industrial participants do not actively participate in emissions trading or adopt new technology. When the prices of RTCs are high, industrial participants will try to lobby the government to increase the cap. Thus, an environmental market is subject to political manipulation by special interest politics. 5.4 Assessing the Effectiveness: A Quantitative Approach The purpose of this section is to use an alternative approach to examine the effects of RECLAIM on SO x and NO x compliance in the Southern California. RECLAIM originally attempted to reduce 83% of the emission of NO x and 65% of the emission of SO x in a ten year frame from 1994 to 2003 (Mazmanian, 1999). As shown in Table 5.1 and Table 5.2, annual emissions of NO x and SO 2 from RECLAIM facilities have gradually declined since the implementation in 1994. By the end of 2003, emissions of NO x is 60.7% off the 1994 level, and emissions of SO x is 46.7% off the 1994 level. In the year of 2006, emissions of NO x is 63.8% off the 1994 level, and emissions of SO x is 50.5% off the 1994 level. While these numbers are significant, they have not achieved the original goal. Also, during the year 2000 and 2001, emissions of NO x exceeded the allocation by 19% and 0.18%, respectively. 110 Previous research on RECLAIM’s effectiveness has focused on the facilities covered by RECLAIM (EPA, 2004, Harrison, 2005); yet the validity of previous evaluations may be challenged by the fact that the number of facilities covered by RECLAIM is not constant over these years. For example, the original RECLAIM universe has 394 facilities in 1994; yet from 1994 trough June 30, 2005, 107 new facilities were added into the universe while 69 were excluded, and 128 facilities ceased operation. 32 Thus, an evaluation of RECLAIM needs to address a more reliable definition of the unit of analysis. In this research, I choose to focus on the total emissions from all point sources, 33 which include both RECLAIM facilities and non-RECLAIM facilities. I ask the question whether the implementation of RECLAIM has helped achieve the goal of emissions reduction from point sources in Los Angeles air basin, compared with emissions from point sources at counties in the State of California where emission of SO 2 and NO x are not covered by the emissions trading system. Since point sources are usually the major target of environmental policy, such a treatment may have important implications. However, it is also important to note here that while 32 Source: SCAQMD (2008), Annual RECLAIM Audit Report for the 2006 Compliance Year, March 7, 2008. 33 As defined by the EPA, point sources are those “emit or have the potential to emit at least 10 tons per year of any one hazardous air pollutants, or at least 25 tons per year of a combination of hazardous air pollutants”; area sources are “stationary sources that do not exceed the thresholds for major source designation. They emit less than 10 tons per year of a single hazardous air pollutant and less than 25 tons per year of all hazardous air pollutants combined.” For details, see the website of Environmental Protection Agency, http://www.epa.gov/air/data/neidb.html. 111 point sources provide a more reliable unit for analysis, they include both RECLAIM and non-RECLAIM facilities in the South Coast air basin. 34 5.4.1 Research Hypothesis Based on the analysis above, the major research question is to examine the effects of RECLAIM on emission change. Thus, the research hypothesis is: Using CAT, compared with using CAC, has no different effects on emissions of sulfur dioxide and nitrogen dioxide. To limit the scope of this research, I will only focus on the effects of policy difference in the State of California between 1990 and 1999. I will propose a reduced-form model based on existing emission models and then use them as the basis for an empirical study of the effectiveness of emissions trading. 5.4.2 Model Specification The model specification is based on a hedonic model that links the relationship between per capita emission level and per capita personal income level of several pollutants, such as sulfur dioxide, carbon dioxide, etc (Stern et. al, 1996, Stern et al., 2001, Harbaugh et al, 2002), and panel data is analyzed to examine the impacts of income growth on pollution level. Many papers have identified that economic development is the major cause for emission increase and reduction in different states of development. Grossman and Krueger (1995) are among the first few economists to use this model to test an inverted U relationship between emission level and income 34 Emissions from the RECLAIM facilities are usually smaller than the total emissions from all point sources within the four counties (Los Angeles, Orange, Riverside, and San Bernardino). From 1994 to 1999, NOx emissions from the RECLAIM facilities are 20-50% of the total emissions from all point sources with the four counties. For SO 2 , this number ranges from 58%-70%. 112 level among different countries (also called environmental Kuznets Curve). In developing countries, emission level will increase with economic growth when per capita personal income is below a turning point. In developed countries, emission level will decrease with the economic growth. This line of literature may imply that since the U.S. is one of the most developed countries in this planet, the relationship between emission level and income level in the U.S. is a negative one. There are various other explanations about the causes of emission reduction from different perspectives. At the macroeconomic level, the changes in total emission can be decomposed into three components: economic development, economic structural change, and technological change (Blok et al., 2004). At the firm level, the environmental performance of firms is largely influenced by market pressures, technological innovations and regulatory incentives (Anton et al., 2004). While technological innovations are recognized as the major factors in emission reduction, the incentives of technological innovation to achieve less emission are primarily produced by policy instruments (Fischer et. al, 2003). Thus, technological innovation can be regarded as an endogenous variable in policy instrument choice (Fischer et. al, 2003). In this research, I use regulatory factor to capture the impact of technological innovations. Based on the existing literature and analysis above, two models are constructed for this research. Model 1: First of all, I construct a baseline model (Model 1) that includes only income factor. E it = α i + β 1 * PPI it + β 2 * PPI it-1 + ∑ γ i * D i + ε it (5.1) 113 i refers to a county (i=1, 2, 3,…58) t refers to the year (1990 is the baseline, for 1990 to 1999, t=1, 2, 3 , … 10, respectively). ε = error term In Model 1, E it denotes the per capita emission of a specific air pollutant in county i in a specific year t. There are two types of air pollutants: NO x from point sources, and SO 2 from point sources. Thus, there are actually two dependent variables. Although SCAQMD uses regional emissions rather than per capita emissions in RECLAIM’s goal setting, this per capita treatment is used to construct a hedonic model so as to capture the impact of population growth in a region, which may have significant impact on total emissions. PPI it denotes the per capita income of county i in a specific year t. PPI it-1 denotes the per capita personal income of county i in a specific year t-1, which is used to include the lagged effect of per capita income on emission level. D i is a dummy variable vector to control the effect of a county. This model works as the baseline model to test the relationship between per capita income and per capita emission. Model 2: Based on the baseline model, Model 2 is developed by using RECLAIM as a new variable to denote the impact of regulatory regime on emission level. E it = α i + β 1 * PPI it + β 2 * PPI it-1 + ∑ γ i * D i + δ * RECLAIM +ε it (5. 2) For counties covered by the RECLAIM, the dummy variable RECLAIM will be coded as “1”, otherwise RECLAIM will be coded as “0”. 114 5.4.3 Data In this research, I use county-level data of 58 counties of California where the emission of NO x and SO 2 from point sources was regulated by either RECLAIM or command-and-control instruments between 1990 and 1999. A specific description of the time and geographic coverage of this research is presented in Table 5.3. Table 5. 3 Geographical and Period Coverage of This Research Geographic Area County 1990 to 1993 1994 to 1999 RECLAIM area (4 counties) Los Angeles, Orange, Riverside, San Bernardino CAC CAT Non-RECLAIM area (54 counties) Alameda, Alpine, Amador, Butte, Calaveras, Colusa, Contra Costa, Del Norte, El Dorado, Fresno, Glenn, Humboldt, Imperial, Inyo, Kern, Kings, Lake, Lassen, Madera, Marin, Mariposa, Mendocino, Merced, Modoc, Mono, Monterey, Napa, Nevada, Placer, Plumas, Sacramento, San Benito , San Diego , San Francisco , San Joaquin , San Luis Obispo , San Mateo, Santa Barbara, Santa Clara, Santa Cruz, Shasta, Sierra, Siskiyou, Solano, Sonoma, Stanislaus, Sutter, Tehama, Trinity, Tulare, Tuolumne, Ventura, Yolo, Yuba. CAC CAC Pollutants: Nitrogen Oxides, Sulfur Dioxide CAC: Command-and-control CAT: Cap-and-trade Data sources (1) Annual emission level of SO 2 and NO x The annual emissions of SO 2 and NO x from point sources at the county-level are taken from the U.S. Environmental Protection Agency. These data were obtained from EPA's National Emission Inventory (NEI) and National Emissions Trend (NET) database, which are used by the U.S. EPA to provide online annual data of sulfur dioxide and nitrogen dioxide emission from both point sources and area sources of 115 each county. 35 In this research, I will focus on emission from point sources that may be regulated by emissions trading systems. I obtained the data for the period of 1990-1999. To get the per capita emission level, I also obtained population of each county in each year from the U.S. CENSUS. (2) Population Annual County-level population data was taken from the Population Estimates Program of the U.S. CENSUS Bureau. 36 The most accurate data about population is provided by the CENSUS only once for every ten years, for example, CENSUS 1990 and CENSUS 2000. The Population Estimates Program only provides estimated population data at the county level for every year. Since it is the best available data for county level population, I chose to use it in this research. (3) Per-capita personal income Annual County-level data of per-capita personal income from were taken from the Bureau of Economic Analysis of the U.S. Department of Commerce. 37 This source provides annual data of per-capita personal income from 1969 to 2002. (4) Inflation rates Since per capita personal income data is nominal, inflation rates from 1989 to 1999 were taken from the Depart of Labor to get the real value of these data. 38 35 For details, see the website of EPA, http://www.epa.gov/air/data/. 36 For details, see the website of CENSUS, http://www.census.gov/popest/archives/1990s/#county. 37 For details, see the website of Bureau of Economic Analysis of the U.S. Department of Commerce, http://www.bea.doc.gov/bea/regional/statelocal.htm, visited on April 22, 2005. 38 For details, see the website of the Department of Labor, http://www.bls.gov/cpi/home.htm, visited on April 22, 2005. 116 Data collection and processing All of these data are provided by governmental agencies and available to the public through online service. The major method of data collection is through online downloading. After the data collection, I coded each county. The data in nominal dollars (per capita personal income) is transformed into real dollars by using the 1990 dollar as the baseline. The emission data in short ton are transformed to pound-based data. All data are put into a single data set. 5.4.4 Empirical Results SPSS 11.0 was used to conduct this research, and Ordinary Least Squares (OLS) was used to test the models. The two models were run with both raw (untransformed) and logged (transformed) data of per capita income. The unit of analysis is county. The empirical results are presented in Table 5.4 and 5.5. Each table contains the regression results of three models that are used to examine the policy impacts on emission level of one category of air pollutant. Table 5. 4 Effects of RECLAIM on NO x Emission Per Capita Emission of NO x from Point Sources: 1990-1999 Model 1 Model 2 PPI Logged PPI PPI Logged PPI PPI PPI- RECLAIM -0.41 (-2.911)*** 0.197 (1.149) -0.456 (-3.554)*** 0.185 (1.269) -0.382 (-2.668)*** 0.156 (0.884) -0.027 (-1.053) -0.435 (-3.361)*** 0.15 (1.005) -0.028 (-1.116) Sample size Adjusted R Square 580 0.849 580 0.85 580 0.854 580 0.855 Standardized coefficient with t score in parenthesis * Significant at p < 0.1 ** Significant at p < 0.05 *** Significant at p < 0.01 117 Table 5. 5 Effects of RECLAIM on SO 2 Emission Per Capita Emission of SO 2 from Point Sources: 1990-1999 Model 1 Model 2 PPI Logged PPI PPI Logged PPI PPI PPI- RECLAIM -0.992 (-3.264)*** 1.18 (3.188)*** -1.025 (-3.715)*** 1.130 (3.604)*** -1.031 (-3.335)*** 1.24 (3.261)*** 0.038 (0.696) -1.053 (-3.776)*** 1.178 (3.67)*** 0.03 (0.76) Sample size Adjusted R Square 580 0.3 580 0.305 580 0.299 580 0.304 Standardized coefficient with t score in parenthesis * Significant at p < 0.1 ** Significant at p < 0.05 *** Significant at p < 0.01 In the baseline model (Model 1), the OLS regressions indicate that PPI (per capita income) has a significant and negative relationship with the per capita emission of NO x and SO 2 from point sources (p<0.01) (Table 5.4 and Table 5.5). OLS analyses of both the raw data and logged data of PPI show the same results. The major surprise is that the significant effects of using RECLAIM on emission reduction have not been found. It was expected that the effects of policy difference would be negative and significant. However, according to Table 5.4 and Table 5.5, the significance of RECLAIM is either positive or negative at a very limited level and non-consistent. It seems that the implementation of emissions trading did not result in a significant change on the per capita emission level of NO x and SO 2 from point sources at the county level. 118 5.5. Discussion This research examines the fixed-effects of emissions trading on per capita emissions from point sources in California in the 1990’s. The OLS regression results fail to reject the null hypothesis that using CAT, compared with using CAC, has no significantly different effects on emissions of both NO x and SO 2 from point sources at the county level in California during 1990’s. While the models presented in this research are not perfect, this research implies that CAT might not be more or less effective than CAC in terms of reducing per capita emission levels. Stated differently, emissions trading has helped SCAQMD reduced emissions of NO x and SO 2 from point sources at the same level of effectiveness of CAC. One of the major findings is that per capita income is significantly related to per capita emission level of both NO x and SO 2 from point sources. Per capita income has a negative relationship with per capita emission level. Do these results suggest that economic factor is more important than regulatory factors in emission reduction? Based on the results in this research, it seems that per-capita emission reduction level has been primarily driven by income growth rather than difference in policy instruments. However, one has to be cautious when accepting the argument above. Firstly, the linear assumption about the relationship between per capita emission level and per capita income level is still in debate, and any attempt to link it to a casual relationship need more supports. While a simplified linear model is developed in this research, it is still incomplete. Since these models are derived from the environmental Kuznets Curve (EKC), it has to face the criticisms to the robustness of EKC model. For 119 example, Stern et al. (1996) indicate that environmental conditions and economic growth are interdependent for many countries. Moreover, Stern et al. (1996, p. 1159) suggest that “the forms of structural models, rather than reduced form models of the EKC” are good for policy analysis. Secondly, this research may have selection bias. As Greenstone (2004, p. 589) indicates, “the ideal analysis of the relationship between air pollution and environmental regulations would involved a controlled experiment in which the regulations are randomly assigned”. This research does not fit this criterion. Counties covered by the RECLAIM program were the most polluted in the State of California. Since regional emissions trading program has not been popular in the U.S., the experimental conditions for a controlled experiment may be difficult to meet. 5.6. Concluding Remarks A well-functioning market of emissions trading is not automatically guaranteed by the implementation of a cap-and-trade program. RECLAIM has helped reduce the emissions in the South Coast Air Basin; yet its performance is not as satisfactory as expected, and one of the major reasons is that the interest group politics has played a major role in the design and implementation of RECLAIM, and this distorted market of emissions trading has not worked as effectively as expected. However, it does not necessarily mean that market mechanisms cannot achieve emission reduction. On the very contrary, even a distorted market can still work. This research finds that the performance of the RECLAIM program is negatively impacted by inadequate design parameters, such as excessive initial allocation of RTCs, politics of interest groups, and the lack of citizen participation. 120 The RECLAIM program has not effectively involved citizen participation, and public pressure for industrial participants to adopt new technologies has been limited. RECLAIM’s experiences have two important implications for future implementation of emissions trading. Firstly, how to set a cap is indeed a political issue. Although the implementation of RECLAIM has mitigated the problems of air pollution in the Los Angeles air basin, this region is still one of the most polluted areas in the U.S. Environmental and health costs induced by air pollution are huge losses to people living in this area. To effectively reduce air pollution, lowering the cap may be considered. Yet since 2003, the caps for both SO 2 and NO x have been stabilized. The prices of RTCs are still low. The major barrier for active trading is that industrial participants are not sensitive to the price signals, which is induced partially by the overwhelming excess of the initial cap and partially by the politics of interest groups. Thus, lowering the cap will increase the prices of RTCs, and trading activities will be encouraged. However, sometimes governmental agency has to compromise to ensure the continuous operation of this program. Secondly, an implementation agency should try to lower transaction costs in the market. The market of emissions trading is not an unrestricted free market that does not require regulation. It is influenced by many factors not controlled by the market itself. Unlike the traditional market of private goods, the environmental market calls for stricter regulation on compliance and transactions so as to prevent inappropriate behaviors, such as price manipulation and cheating. The SCAQMD should continue to provide information, emissions trading training, and other 121 assistance to make industrial participants more active in emissions trading. The Federal and State environmental agencies (EPA and California Air Resources Board) are also important in the implementation of RECLAIM. This chapter fails to reject the hypothesis that cap-and-trade emissions trading is more or less effective in terms of emission reduction of both NO x and SO 2 from point sources at the county level in California in the 1990’s. This result may imply that even a distorted market can produce environmental outcomes that are equivalent to that under the command-and-control regime. However, to examine the environmental outcomes of different policy instruments, one must admit that many of the underlying processes of emission reduction are not fully understood. Moreover, there are several limitations of this evaluation research. Since the RECLAIM is a unique program in the U.S. and the world, it is difficult to incorporate the experiences of other market-based environmental programs into this research or compare this program with any other regional programs. Thus, it is not easy to examine the validity of the findings and conclusion of this research. In other words, the effectiveness of CAT is still an open question, and more empirical studies are needed to examine how market design may impact the environmental outcomes of emissions trading. 122 Chapter 6 Discussion and Conclusion Cap-and-trade emissions trading has been advocated as one of the most promising market-based policy instruments, and in recent years it is suggested as an important policy tool for addressing the challenges of air pollution and global climate change. Yet the debate on emissions trading has never ended, and the performance of emissions trading has been increasingly questioned by environmentalists, policy scholars, and even some prestigious economists, such as Joseph Stiglitz. 39 Indeed, the implementation of emissions trading system is not an easy task. One senior officer at SCAQMD indicates that implementing a regional cap-and-trade program requires strong regulatory capacity and careful strategic planning. 40 In other words, a good history of command-and-control regulatory experiences may be necessary for both regulators and businesses to move towards market-based environmental governance. Nevertheless, Los Angeles’s experiences might not be replicable since there are very few places in this world with similar environmental conditions and strong regulatory traditions. In sum, emissions trading system is subject to failure if it is not adequately designed and implemented. Yet regulatory design and implementation of emissions trading is political, and thus scholarly attention should be paid to its political and administrative aspects, which may have been overlooked in previous economic models of emissions trading. 39 For example, Joe Stigliz (2007), Showdown in Bali, http://www.project-syndicate.org/commentary/stiglitz94. 40 Interviewee from SCAQMD. 123 6.1. Summary of Major Findings In this dissertation, I examine the implementation of an emissions trading program from both theoretical and empirical perspectives. Rulemaking is treated as a key part of policy implementation in this research, and I have applied transaction-cost politics theory to develop a model of environmental policy implementation, and I have used both qualitative and quantitative methods to explain the interest group politics and institutional choices in the implementation of RECLAIM (Regional Clean Air Incentives Market), the first regional emission permits trading program. Specifically, it focuses on the interactions among numerous key interest groups: federal, state and local governments, businesses, and environmental NGOs, and how these interest groups work with the implementation agency to design and enforce a market-based environmental policy in one of the largest metropolitan areas in the world. This dissertation has identified numerous political and administrative challenges to effective implementation of cap-and-trade emissions trading systems. In this dissertation, I develop a game theoretic model of agency rulemaking and analyze the role of bureaucratic discretion during environmental policy implementation. This model integrates existing theories of policy implementation, institutional rational choice and transaction cost politics. I argue that administrative agency tries to minimize political transaction costs of policy implementation when writing rules. This model predicts that 1) rulemaking outputs are conditioned by the implementation agency’s scope of discretion; 2) citizen participation in rulemaking is 124 constrained by participation costs; and 3) comments from different stakeholders may be weighted differently by agency officials. Based on the formal model, I conduct a quantitative analysis of the role of stakeholders in the rulemaking of RECLAIM. This research focuses on the rulemaking activities of RECLAIM. I use binary logistic regression to analyze 277 randomly selected public comments and corresponding agency responses during RECLAIM’s rule formation and revision stages from 1993 to 2005. I find that SCAQMD is more likely to adopt rule changes suggested by state and federal environmental agencies in both the rule formation and revision stages. This research identifies the dominant role of organized interest groups in rulemaking of RECLAIM, the existence of interagency lobbying and the lack of citizen control over SCAQMD’s rulemaking of RECLAIM. Furthermore, I conduct an evaluation of the rules governing the RECLAIM program, and I identify the major distortions of the RECLAIM rules in comparison with those of an ideal emissions trading market. Also, I use OLS regression to examine the effects of policy difference on emission level in the State of California between 1990 and 1999. This evaluation research fails to reject the null hypothesis that using cap-and-trade (CAT) compared with using CAC has no different effects on emission change of both NO x and SO 2 from point sources at the county level in California in the 1990’s. In summary, this research finds that the implementation of emissions trading is indeed political. While emissions trading, as an innovative policy instrument, is promising for modern societies to better protect our environment and natural resources, 125 the implementation of emissions trading is conditioned by many political and administrative factors. Inadequate rules may come as the results of political compromises, and they may impact the functioning of an emissions trading system. However, this research also finds that a distorted emissions trading market can still work, although not as perfect as expected. RECLAIM’s experiences of implementation may have significant implications for future practices and research of market-based environmental policies. One notable case is the use of cap-and-trade program to address the challenges of global warming. 6.2. Practical Implications When designing cap-and-trade programs, regulators usually face information asymmetry and need to reveal the preferences of stakeholders over many technological and enforcement issues. Yet we know very little about the role stakeholders play during the regulatory design and implementation processes of emissions trading (Hahn and Stavins, 1992). This dissertation finds that stakeholders have exerted significant impacts over the rulemaking of RECLAIM, which may have implications for the design of other cap-and-trade programs. In this section, I will provide an analysis of California’s carbon trading program. California is a pioneer to address the challenges of global climate change. 41 AB 32 (Assembly Bill 32) was passed in August 2005, and in June 2007, California Air Resources Board’s Market Advisory Board announced that a cap-and-trade system 41 On June 1 st , 2005, Governor Schwarzenegger signed an executive order to establish ambitious targets for California’s GHG emission reduction: “by 2010, reduce GHG emissions to 2000 levels; by 2020, reduce GHG emissions to 1990 levels; by 2050, reduce GHG emissions to 80 percent below 1990 levels.” Source: http://gov.ca.gov/executive-order/1861/ 126 was recommended as the main implementation mechanism (Market Advisory Committee, 2007). While the implementation plan is still in development and there are still debates on various aspects of AB 32, previous emissions trading experiences in the U.S. may highlight some key issues regulators have to consider. In other words, California’s regulators need to pay more attention to the mechanism of emissions trading and how political negotiations among stakeholders may influence the design and implementation of its cap-and-trade program. Currently, there are debates on its design. Should California use a combination of grandfathering and auction? Should CEMS be mandatory? How many sectors and facilities should be covered? All these concerns have been addressed by businesses and environmental groups with very different suggestions. Business groups are more concerned about the costs of a cap-and-trade program, while environmental groups care more about environmental equity/justice issues. Since the rulemaking of cap-and-trade is open to all stakeholders, it is inevitable that California’s cap-and-trade program may come up with some features that are not consistent with market principles as the results of compromises. As the first state in the U.S. to initiate a state-level policy action to the fight against global climate change, California faces a huge political challenge: the free rider problem. Unlike the cap-and-trade programs of SO 2 and NO x that have great local or domestic benefits, the benefits of emission reductions of GHGs are more global. Local efforts to address GHG emissions may provide global public goods, yet the regulatory burdens and compliance costs to the California economy may be tremendous. On the other hand, the leakage problem may also make California’s efforts meaningless (Bushnell et al., 2007, Stavins, 2007). California is considering 127 using load-based GHG Emissions Cap (Burtraw, 2007), yet this may cause more challenges to regulatory agencies when they have to regulate emissions or electricity generated in other states. Also, political resistance from businesses and other groups who have serious concerns on job security will be significant. For example, AB 32 Implementation Group, an online interest group coalition representing more than 140 small and large businesses in California, has tried to express their concerns over governmental actions and to lobby the Governor and regulatory agencies through various channels, and one of their major concerns is implementation costs 42 . Thus, California’s commitment to GHG emission reductions may be conditioned by the problems of emission leakage, free rider and high implementation costs. All these issues may impose huge political challenges to the implementation of AB 32. There are also agency collaboration challenges to California. Currently, California Environmental Protection Agency is charged with the implementation task of AB 32 and the rulemaking of the cap-and-trade program. Yet the implementation of AB 32 or a cap-and-trade program will heavily interfere with other existing regulations, such as energy efficiency, renewable energy, vehicle emission standards, etc. On the other hand, a cap-and-trade program will also involve many regulatory agencies, such as California Energy Commission, California Public Utilities Commission, California Department of Transportation, etc. Moreover, if load-based cap-and-trade scheme and offset mechanism are integrated into this program, the regulatory agency has to regulate emissions happening in other states or other countries. Indeed, the implementation of a cap-and-trade program imposes a great 42 http://www.ab32ig.com/index.htm 128 challenge to the California Environmental Protection Agency. It is unclear whether this agency has enough regulatory or governance capacity to deal with all these governance challenges and to maintain cross-sectoral and inter-agency collaboration. Enforcement and monitoring are also challenging. A well-functioning emissions trading market requires data accuracy. Since the majority of GHGs were not directly regulated by governments in the U.S., there is no well-established procedure and reliable reports of standardized information on the GHG emissions from all sources in California. For example, California is trying to calculate its GHG emissions at the facility level in 1990. Currently, California Climate Action Registry is trying to establish a voluntary reporting system, yet data accuracy is still a major problem in this system. One governmental employee at CEC interviewed indicates that “the CEC and CPUC are in the midst of a proceeding to standardize reporting conventions”. 43 However, California still needs to make a trade-off between data accuracy and regulatory burden/compliance costs to market participants. In sum, the regulatory challenges are huge. More attention should be paid to details of mechanism design and institutional factors of California’s cap-and-trade emissions trading system. 6.3 Theoretical Implications, Limitations, and Future Research This research finds that the rulemaking of an emissions trading system involves many organized stakeholders, and it is political in nature. While recent years have witnessed the increasing applications of cap-and-trade emissions trading, some of 43 Personal contact with an employee of California Energy Commission employee, August 2007. 129 the existing programs are based on distorted market mechanisms. Although a number of studies have attempted to identify the existence and the extent of economic transaction costs in emissions trading markets, little has been written on the political source of transaction costs: the dynamics of rulemaking and political compromises. This research explores the implementation of emissions trading from the political and administrative perspectives, and it has identified the impacts of political and administrative factors on market-based environmental policy process. This research has several limitations. The formal model developed in this research is still preliminary. The empirical part of this dissertation also lacks qualitative information. While this research relies primarily on archived data, it will be valuable if more interviews are conducted with governmental officials and interested stakeholders, such as environmental NGOs, businesses, and the scientific community to explore the participation experiences of various interest groups in the design of RECLAIM. An expansion of this research will be a comparative case study on emissions trading programs in the U.S., the European Union, China, and other places. Since these regions are major players in global environmental governance and all of them have experimented with emissions trading in recent years (Stavins, 1998, Ellerman et al., 2000, Wang et al., 2004, Woerdman, 2004), it will be very meaningful to examine the impacts of various interest groups/stakeholders on policy outputs, and how the conflict between expertise and democracy is resolved in the public policy process. Moreover, since their social norms, political structures and regulatory styles are quite 130 different, their experiences will be important for future market-based solutions for global and regional environmental challenges. 131 Appendices Appendix 1 Minimization Solution to the Political Transaction Cost Function C(θ,θ * )=α(θ * -θ) 2 + ∑ = m i 1 E(P i ) =α(θ * -θ) 2 + ∑ = m i 1 β i [ (θ i –θ) 2 –T i ] The solution of the optimal cost function is 0 = ∂ ∂ θ C , s.t. θ∈[θ L ,θ H ]. Thus, we have the final policy outcome θ A Rule Withdrawal, if (α*θ * +∑β i *θ i )/ (α+∑β i )<<θ L θ L , if (α*θ * +∑β i *θ i )/ (α+∑β i )<=θ L θ A = (α*θ * +∑β i *θ i )/ (α+∑β i ), ifθ L < (α*θ * +∑β i *θ i )/ (α+∑β i )<θ H θ H , if (α*θ * +∑β i *θ i )/ (α+∑β i )>=θ H Rule Withdrawal, if (α*θ * +∑β i *θ i )/ (α+∑β i )>>θ H 132 Appendix 2 List of RECLAIM Rules Rule 2000 General (Amended May 6, 2005) Rule 2001 Applicability (Amended May 6, 2005) Rule 2002 Allocations for Oxides of Nitrogen (NO x ) and Oxides of Sulfur (SOx) (Amended January 7, 2005) Rule 2003 Reserved Rule 2004 Requirements (Amended April 6, 2007) Rule 2005 New Source Review for RECLAIM (Amended May 6, 2005) Rule 2006 Permits (Amended May 11, 2001) Rule 2007 Trading Requirements (Amended April 6, 2007) Rule 2008 Mobile Source Credits (Adopted October 15, 1993) Rule 2009 Compliance Plan for Power Producing Facilities (Amended January 7, 2005) Rule 2009.1 Compliance Plans for Forecast Reports for Non Power Producing Facilities (Adopted May 11, 2001) Rule 2010 Administrative Remedies and Sanctions (Amended April 6, 2007) Rule 2011 Requirements for Monitoring, Reporting, and Recordkeeping for Oxides of Sulfur (SOx) Emissions (Amended May 6, 2005) Rule 2011 Protocol for Monitoring, Reporting, and Recordkeeping for Oxides of Sulfur (SOx) Emissions (Amended May 6, 2005) Rule 2012 Requirements for Monitoring, Reporting, and Recordkeeping for Oxides of Nitrogen (NO x ) Emissions (Amended May 6, 2005) Rule 2013 Reserved Rule 2014 Reserved Rule 2015 Backstop Provisions (Amended June 4, 2004) Rule 2020 RECLAIM Reserve (Adopted May 11, 2001) Source: the website of SCAQMD Web link: http://www.aqmd.gov/rules/reg/reg20_tofc.html 133 Appendix 3 Variable Descriptions and Coding Strategy Type Variable Description Coding Strategy Stakeholder Information Name Name of the commenter Record the name of the commenter IND Is this commenter an individual or citizen? If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. NGO Is this commenter from an environmental or nonprofit organization? If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. BUS Is this commenter from a business? If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. GOV Is this commenter from a governmental agency? If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. Other Is this commenter from other type of organizations? If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. Comment Information REG What’s the regulatory direction suggested by this comment? If the commenter calls for more governmental regulations, stricter enforcement or less flexibility, more ambitious emission reduction goal, its regulatory direction will be coded as “1”. If the commenter calls for less governmental regulations, loose enforcement or more flexibility, it will be coded as “-1”. If a comment has no specific regulatory direction, it will be coded as “0”. Market What’s the market-orientation of this comment? This variable will be coded as “1” if the comment calls for a regulatory change that is more market-oriented, and “-1” if the comment calls for a regulatory change that is less market-oriented, and “0” otherwise Enforcement What’s the enforcement flexibility implication of this comment? This variable will be coded as “1” if the comment calls for more enforcement flexibility, and “-1” if the comment calls for less enforcement flexibility, and “0” otherwise. 134 Goal What’s the cap implication of this comment? This variable will be coded as “1” if the comment calls for an increase of the cap, and “-1” if the comment calls for a decrease of the cap, and “0” otherwise Issue Information Complexity Is this comment addressing technological or regulatory uncertainties If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. Salience Is this comment also supported by other commenter(s) during the same stage of rule revision? If the answer is “yes”, this variable will be coded as “1”; otherwise “0”. Stage Information Stage Was this comment submitted during the rule formation or revision stage? If this comment is submitted before 1994, this variable will be coded as “0”; otherwise “1”. Agency Response Change SCAQMD made requested regulatory change/action? If SCAQMD made suggested rule change, this variable will be coded as “1”; otherwise “0”. 135 Appendix 4 Questionnaire Questions Has the RECLAIM program effectively reduced the air pollution in Los Angeles Basin in recent years? What are the main barriers to emissions trading industrial participants have experienced in the implementation process of the RECLAIM? (The barriers might be regulatory, technical, economic, or any other factors.) How can these barriers be overcome to make industrial polluters more active in trading activities? 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Abstract (if available)
Abstract
This research provides a positive explanation of the implementation processes and effects of market-based environmental policy by conducting a case study on RECLAIM (Regional Clean Air Incentives Market), the first regional emission permits trading program that has been implemented by South Coast Air Quality Management District (SCAQMD) to address air pollution problems in the Los Angeles air basin since 1994.
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University of Southern California Dissertations and Theses
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Asset Metadata
Creator
Zhan, Xueyong
(author)
Core Title
Processes, effects, and the implementation of market-based environmental policy: southern California's experiences with emissions trading
School
School of Policy, Planning, and Development
Degree
Doctor of Philosophy
Degree Program
Public Administration
Publication Date
10/30/2008
Defense Date
07/01/2008
Publisher
University of Southern California
(original),
University of Southern California. Libraries
(digital)
Tag
emissions trading,environmental governance,implementation,OAI-PMH Harvest,RECLAIM,rulemaking
Place Name
California
(states),
Los Angeles
(city or populated place)
Language
English
Contributor
Electronically uploaded by the author
(provenance)
Advisor
Tang, Shui-Yan (
committee chair
), Henry, Ronald (
committee member
), Mazmanian, Daniel A. (
committee member
)
Creator Email
xueyongzhan@gmail.com,xzhan@usc.edu
Permanent Link (DOI)
https://doi.org/10.25549/usctheses-m1719
Unique identifier
UC1446792
Identifier
etd-Zhan-2335 (filename),usctheses-m40 (legacy collection record id),usctheses-c127-120246 (legacy record id),usctheses-m1719 (legacy record id)
Legacy Identifier
etd-Zhan-2335.pdf
Dmrecord
120246
Document Type
Dissertation
Rights
Zhan, Xueyong
Type
texts
Source
University of Southern California
(contributing entity),
University of Southern California Dissertations and Theses
(collection)
Repository Name
Libraries, University of Southern California
Repository Location
Los Angeles, California
Repository Email
cisadmin@lib.usc.edu
Tags
emissions trading
environmental governance
implementation
RECLAIM
rulemaking