The environment as a factor of production

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jeem.2006.07.001 Byline: Timothy J. Considine (a), Donald F. Larson (b) Keywords: Emissions; Permits; Substitution Abstract: This paper uses firm-level data about electric utilities to develop an empirical model of how electric utilities use and bank SO.sub.2 pollution permits under the Acid Rain Program. The empirical model considers emissions, fuels, and labor as variable inputs with quasi-fixed stocks of permits and capital. Consequently, substitution possibilities between the environment and other production factors can be measured and tested. The results reveal substantial substitution between emissions, permit stocks, capital, fuel, and labor. The empirical findings also indicate that firms bank permits primarily as a hedge against uncertainty and for other firm-specific reasons. Overall, the results suggest that cap-and-trade approaches can reduce the cost of meeting environmental goals by providing a mechanism for addressing regulatory and market risks and by signaling an appropriate price for factor use, especially irreversible capital investments. Author Affiliation: (a) The Pennsylvania State University, 125 Hosler, University Park, PA 16802, USA (b) Development Research Group, World Bank, 1818H. Street, NW, Washington, DC 20433, USA Article History: Received 4 October 2004