Location Key to Pollution’s Real Cost

By Jon Luoma

From an economic standpoint, air pollution has something oddly in common with real estate, according to Robert Mendelsohn, Edwin Weyerhaeuser Davis Professor of Forest Policy at F&ES.

“It’s all about location, location, location,” he says. “Just as where a house is located makes a big difference in its value, a polluter’s location can make a huge difference in terms of the economic consequences of its emissions.”

To help prove that point, Mendelsohn and Nicholas Muller, an assistant professor of economics at Middlebury College who earned his Ph.D. at F&ES in 2007, recently estimated that an extra ton of a single pollutant, sulfur dioxide (SO₂), spewed from a power plant in, say, parts of the New York metropolitan area would cost society 50 times more than that same ton emitted in the rural Pacific Northwest. Most of that cost involves harm to human health, although the two economists also con-sidered other factors, including the known damage that pollution can do to crops, forests and man-made materials.

Other researchers have documented various ways that location matters when it comes to air pollution emissions. But in a detailed analysis published in the December 2009 issue of The American Economic Review, Mendelsohn and Muller looked at the costs of that location-specific damage in a new way. Their research not only has provided more clarity about just how large economic disparities in air pollution damage can be from one location to another, it also offers a rationale for using that knowledge to sharply reduce the costs of pollution in an economically efficient way, with benefits dramatically outweighing cleanup costs.

Mendelsohn and Muller propose a new era in pollution regulation that recognizes, as Muller puts it, that “just as different goods have different prices, pollution emissions in different places have different costs. Our approach would improve air pollution control by recognizing the heterogeneity of these costs.”

The approach would maintain, at mini-mum, current air quality standards for all areas. But it would add a market-based program of tradable credits, designed to effectively compel polluters that do the most harm to pay the highest costs. The idea is to provide clear economic signals to induce an electric utility to, say, switch from a dirtier fuel to a cleaner one or locate a power plant downwind and farther from a major metro area, rather than upwind and closer, whenever the overall benefits notably outweigh the costs.

Just considering one pollutant from one major source, SO₂ from power plants, their article estimates that the net savings (benefits to society minus extra pollution control costs) from improved, economically targeted pollution control would be as high as $7 billion to $8 billion annually. If SO₂ control was expanded to all of the roughly 10,000 emitters of the compound, savings could reach as high as $20 billion per year. Add in other air pollutants and the number could soar much higher.

The bottom line for targeting reductions based on location, says Muller, is that “improvement in health damage, in par-ticular, far outweighs the abatement costs.” He adds that the approach could be applied not only to multiple air pollutants but to water and land pollution as well, yielding many billions in additional savings.

Comprehensive nationwide air pollution regulation in the United States began with passage of the Clean Air Act in 1970. The new law recognized that air pollution crossed boundaries, making it difficult for states to regulate pollution individually. The act led the federal government and the states to establish standards for ambient air quality and to mandate end-of-pipe technologies (such as scrubbers and catalytic converters) or pollution limits for emitters based on their size. That first wave of regulation is often called “command-and-control,” because it dictates what each firm should do.

Capping pollution certainly brought cleaner air and clear benefits. For instance, a 2009 analysis in The New England Journal of Medicine estimated that the partial cleanup in fine particulates (the tiniest components of soot) between 1980 and 2000 alone led to a five-month increase in life expectancy in 51 large U.S. cities.

Revisions to the Clean Air Act in 1990 introduced a new regulatory approach. In an attempt to limit the cost of controlling SO₂, the main component in acid rain, Congress that year introduced the concept of adding a market-based mechanism—the nation’s first cap-and-trade program—aimed at utilities that burned coal and other fossil fuels. The program set a nationwide cap limiting U.S. utilities’ annual SO₂ emissions to 10.2 million tons. Each emitter was awarded permits for each ton of emissions that it would be allowed under the cap. Utilities that found it economical to reduce emissions below their allowances could sell unused allowances to emitters that found it more difficult. Congress reasoned that market forces would tend to drive utilities to clean up pollution where it was most cost-effective to do so.

The approach turned out to be more effective than anyone predicted. Not only did the program push emissions below the cap, but the federal Office of Management and Budget has estimated that the cost amounted to between $1.1 billion and $1.8 billion, only 20 to 30 percent of the Environmental Protection Agency’s initial projections. By 2002, The Economist was hailing the program as “probably the greatest green success story of the past decade.”

The United States later introduced a more limited cap-and-trade scheme to help control another class of pollutants, nitrogen oxides (NO^x), emitted in several Eastern states. Mendelsohn and Muller dub cap-and-trade—this second wave of air pollution control—the “cost-effective” approach.

Their recent article proposes a sweeping new modification, introducing a pollution abatement regime that is not only cost-effective, but also much more economically efficient.

“We’re proposing a third revolution in air pollution control,” says Mendelsohn.

Under their proposal, existing air quality standards would remain in place everywhere, but a redesigned system of tradable credits would provide polluters who do the most economic damage with a major incentive to do the most to reduce emissions. At the top of the list are polluters in or directly upwind of large metropolitan areas, where both the intensity and the costs of pollution tend to run highest simply due to high population densities. The regime could induce emitters to tighten controls wherever economic benefits clearly outpaced cleanup costs.