Markup dispersion, industry coverage and the cost of environmental regulation

Abstract

The environmental economics literature has long established that all polluters should be regulated to equalize their marginal abatement costs. We make the case for “partial coverage” where only a subset of polluting industries is regulated. Environmental regulation, by moving factors of production from dirtier to cleaner industries, ameliorates the costs of imperfect competition if the cleaner industries also have higher markups. The selection of industries to be regulated depends on the correlation between industry markups and dirtiness, and may not be those with the highest emissions. Partial coverage may dominate full coverage when the abatement target is moderate. We apply the model to environmental regulation in China and show that significant cost savings can be achieved by switching from full to partial coverage.