Evaluating environmental regulations outside the box

Maricopa County, Arizona is proposing to implement 53 measures to cut pollution from tiny particles (PM-10) that are small enough to be inhaled. The "Five Percent Plan" estimates the cost to range from from $4 per ton of PM-10 for certified street sweepers to $2,534,000 per ton of PM-10 for repaving or overlaying paved roads with rubberized asphalt. The cost of the policy mandating a dust control manager at sites larger than 50 acres was calculated by first adding the cost of a day-long dust control training course, more frequent watering at construction sites, and the full-time employment of a dust manager (with an average salary 10% higher than a foreman or construction supervisor). But Kerry Smith, professor of economics at the W. P. Carey School of Business, suggests that calculating the full cost of the PM-control policies is more complex, and requires a new look at the way we account for the interrelationships in an economy.

Phoenix area residents can expect to see more dust control managers at construction sites in the Valley of the Sun these days, and 15 mile per hour speed limits on dirt roads, and restrictions on vehicle use on vacant lots. They can forget about using a leaf blower on high pollution advisory days, too.

Those are just some of the 53 measures that the Maricopa Association of Governments has proposed as part of its "2007 Five Percent Plan for PM-10." The plan aims to reduce particulate matter pollution in Maricopa County by at least five percent a year until the County meets the EPA's clean air standards. The plan was developed as a response to a June, 2007 notice from the federal Environmental Protection Agency (EPA) that Maricopa County failed to attain the PM-10 standard by the 2006 deadline.

Particulate matter, or PM, is defined by the EPA as "a complex mixture of extremely small particles and liquid droplets. Particle pollution is made up of a number of components, including acids (such as nitrates and sulfates), organic chemicals, metals, and soil or dust particles."

PM-10 refers to particles that are up to 10 micrometers in diameter — what the EPA calls "inhalable coarse particles" such as dust. Because PM-10 can enter the lungs, it can cause serious health problems, including coughing and difficulty breathing, decreased lung function, aggravated asthma, development of chronic bronchitis, irregular heartbeat, nonfatal heart attacks, and premature death in people with heart or lung disease, according to the EPA.

Maricopa County exceeded the maximum level of PM-10 on 19 days in 2005 and 21 days in 2006. The Maricopa County Department of Air Quality estimates that 36 percent of the County's particulate matter pollution came from the construction industry (including residential, commercial, and road construction). Dust from both paved and unpaved roads contributed another 26 percent of the PM.

Estimating the costs of the Five Percent Plan policies

The Five Percent Plan estimates the costs of its 53 proposed PM-control policies. They range from $4 per ton of PM-10 controlled for certified street sweepers to $2,534,000 per ton of PM-10 controlled for repaving or overlaying paved roads with rubberized asphalt. The calculation of cost in the Five Percent Plan is fairly straightforward.

For example, the cost of the policy mandating a dust control manager at sites larger than 50 acres was calculated by first adding the cost of a day-long dust control training course, more frequent watering at construction sites, and the full-time employment of a dust manager (with an average salary 10% higher than a foreman or construction supervisor). The Plan estimates that cost at $2,865 per day.

The plan calculated the cost, allowing a measure of the effectiveness of the action, so it is in terms of the pollution reduction (i.e. reduced particulate matter) that $2,865 per day could buy. To do this, the Plan looked to a recently completed study that found a baseline control efficiency of 50 percent (without the new policy) and assumed that the new policy would increase control efficiency to 70 percent.

That translates into a daily reduction of 402 pounds of PM-10 per day. Dividing a cost of $2,865 per day by the daily reduction of 402 pounds of PM-10, the full cost of the dust control manager policy is $7.14 per pound, or $14,285 per ton of PM-10 reduced.

But Kerry Smith, professor of economics at the W. P. Carey School of Business, suggests that calculating the full cost of the PM-control policies imposed on the economy as a whole is more complex. When the changes are large, the economic method for calculating the cost of a regulation requires a general equilibrium analysis, which accounts for the interrelationships in an economy.

To accurately account for the cost of the dust control managers, Smith would start with the costs outlined in the Maricopa Plan (including training, more frequent watering, and full-time employment of a dust manager). But those costs ripple through the economy. "Hiring a dust control manager increases costs for the construction firm, which must pass those costs on to its consumers," Smith said.

"Because construction costs have increased, rents recovered from the buildings that are constructed must increase, as well. Facing increasing rents, employees demand higher wages, and thus a large enough change in one place in the economy will inevitably affect the costs of many other commodities." Moreover this is not the end of story. Air quality is improved and the health effects of pollution reduced. Thus we can expect lower expenditures for health care and medicines that are associated with the health effects of pollution.

Ultimately, Smith said, the question becomes: How much would incomes have to change to offset the combination of the rising costs (including rents and commodity prices) associated with the dust control manager and the improvements in air quality conditions (with reduced health costs)? Traditional general equilibrium models cannot fully answer the question because they leave out the environment — meaning that air quality improvements and their associated health benefits don't "count."

Economics 101

"The circular flow is probably the first 'model' of economic activity that economics students learn," Smith writes in a book chapter called "Environmental Economics and the 'Curse' of the Circular Flow" (published in "Frontiers in Resource and Rural Economics").

"It describes the parallel real and monetary flows that characterize all the 'important' interactions that constitute economic activity. The flows are treated as taking place exclusively within markets." And there's the rub. The circular flow "model" limits important economic interactions to those in markets. In fact, Smith cautions that the circular flow is not really a model at all, but a metaphor used to teach students about basic economic interactions.

In reality, Smith said, there are non-market effects — like health effects avoided when air quality is improved — that are also important when considering, say, the cost of an environmental regulation. "Economic interactions outside markets influence what takes place inside those markets," Smith writes. "This conclusion seems like common sense and would no doubt be widely accepted by the lay public. There appears to be much less acceptance among mainstream economists."

Thinking outside the box

Coming back to the dust control manager example, Smith said that important non-market effects might include the health benefits that come with cleaner air. "Maybe a reduction in particulate matter means that people go to the doctor less frequently," Smith said. "Maybe they have to buy less asthma medicine. Maybe they enjoy their leisure time more. Maybe more tourists come and visit. All of those are important benefits that should be factored into the general equilibrium analysis for large changes to the economy."

Those health benefits may well offset all or part of the costs associated with environmental regulations. Yet they're not factored into the traditional general equilibrium analysis because conventional practices have been defined by the simple logic portrayed in the circular flow "model," which limits analyses to only those activities that take place in markets.

Of course, it is a matter of degree — how important is the simplification associated with ignoring these non-market effects? The real question, Smith said, is whether the non-market effects would influence the calculation of the cost of the environmental policy. "The answer is: Absolutely," Smith said.

"Before the research associated with including environmental services in a general equilibrium framework, assessments of the importance of non-market effects was largely guess work," explained Smith. "Our findings suggest that adding in those non-market benefits would absolutely change the cost of the regulation." "Benefit effects do matter."

Bottom Line:

• Maricopa County must decrease particulate matter (PM-10) pollution by 5 percent a year to attain compliance with the EPA's Clean Air Act.
• PM-10, inhalable course particles such as dust, can become embedded deep in the lungs and cause serious health problems.
• The full cost of environmental regulations should be calculated using a general equilibrium analysis, which accounts for both the rising economy-wide costs associated with the regulation and the economy-wide gains due to improved environmental quality.
• The formulation of conventional general equilibrium models has been limited by the simplified logic portrayed by the circular flow "model"; it accounts only for interactions within markets.
• There are important non-market effects — such as health effects — that should be accounted for in environmental policy evaluations.
• Adding in non-market benefits appears to reduce assessments of the full costs of environmental regulations.