Working Papers

Emissions taxes and carbon caps can both lead to efficient production of energy,
in the sense of controlling carbon emissions to the extent that is efficient with
existing technologies. However, the regulatory policy has a second objective,
which is to create incentives to develop lower-carbon technologies. With both
objectives in mind, does one policy dominate the other? The answer depends
partly on whether the regulated price of energy is in the elastic or inelastic part
of the demand curve. It also depends on the size of the improvement. Under
tax regulation, an innovator can always profit from diffusing the clean technology
to all producers. This is not true under a carbon cap because diffusion
expands energy supply, reducing the price of energy and of allowances and
eroding the producers’ willingness to pay for licenses. Under cap-and-trade
regulation, the regulator has less ability to control the price of energy while
ensuring productive efficiency (full diffusion). Because there is little incentive
to invest in a larger improvement than will be fully diffused, cap-and-trade
regulation limits innovation in a way that is avoided by a tax.

Many observers are skeptical of claims that private entrepreneurs can perform traditional governmental functions like supporting basic research, keeping WMD away from terrorists, or protecting public health. This article presents five recent counterexamples. These include initiatives designed to establish new health and safety standards in nanotechnology; build a central repository for worldwide mutations data; use on-line volunteers to find cures for tuberculosis; and require biotech companies to screen customer orders for products that can be used to make weapons. In principle, many more initiatives are both possible and desirable. Historically, however, government done little to promote private initiatives and sometimes destabilized them. The article suggests strategies for this overcoming this problem.

WMD technologies are increasingly available from commercial firms located all over the world. Scholars point out that traditional political initiatives based on regulation and treaty will have difficulty controlling this complex environment. By comparison, market forces routinely impose uniform, worldwide standards (e.g. Windows software, Blu-Ray video players) in many high tech industries. Recently, the companies in one such industry (artificial DNA) used these same economic forces to develop and implement a biosecurity standard. Surprisingly, the resulting standard is more stringent – and at least arguably more enforceable – than the US government’s own official guidelines. This article begins by presenting a short history of how private and public standards evolved in the artificial DNA industry. It then goes beyond this motivating example to ask whether we can expect private non-proliferation standards to be similarly effective in other industries. Next, it reviews what modern theories have to say about standard-setting in both government and the private sector. This analysis suggests that private standards should be reasonably feasible, stringent, and enforceable for many dual use industries. Furthermore, theory suggests that private standards will often reflect society’s risk preferences at least as well as public regulation. The article concludes by suggesting specific reforms for improving private and public standards-setting still further.

We consider group formation with asymmetric information. Agents have unverifiable
characteristics as well as the verifiable qualifications required for memberships in groups.
The characteristics can be chosen, such as strategies in games, or can be learned, such
as skills required for jobs. They can also be innate, such as intelligence. We assume that
the unverifiable characteristics are observable ex post (after groups have formed) in the
sense that they may affect the output and utility of other agents in the group. They are
not verifiable ex ante, which means that prices for memberships cannot depend on them,
and they cannot be used for screening members. The setup includes problems as diverse
as moral hazard in teams, screening on ability, and mechanism design. Our analysis,
including the definition of equilibrium and existence, revolves around the randomness
in matching. We characterize the limits on efficiency in such a general equilibrium, and
show that a sufficiently rich set of group types can ensure the existence of an efficient
equilibrium.

Implementation of many policies intended to reduce fuels’ contribution to global warming require an estimate of the global warming intensity (GWI) of various fuels. Determining the climate effect of a direct substitution of fuels is not the same as determining the official value of each fuel’s GWI used to implement the policy. Choosing the second, which depends in part on estimates of the first and their intrinsic uncertainty, is a decision that should reflect the shape of the probability distribution of the first and of the cost of error (the difference between the chosen value and the ‘real’ value. Decision analysis helps clarify the difference between these GWI’s, how they relate to each other, and how standard engineering practice like a safety factor applies to the regulator’s decision.

We discuss welfare and various policy interventions for mixed ICT markets where firms use either 'open source' (OS) or 'closed source' (CS) business models. We find that the existence of OS business models improves social welfare compared to all-CS industries by letting firms share costs and avoid duplication. However, code sharing also establishes a de facto quality-cartel that suppresses OS firms' incentives to invest. Competition from CS firms weakens this cartel and improves welfare. That said, market forces alone provide too little CS competition. We find no support for various government interventions based on tax breaks for OS-based firms and pro-OS procurement preferences by government. However, policies that directly target the
supply of OS code have a positive impact.

The Fair Trade (FT) initiative has been hugely popular with coffee consumers around the world, and
yet the creation of durable producer rents is challenging in a competitive market environment. We
model the FT premium actually received by producers and suggest that rents are in fact dissipated,
but that this occurs in ways that are quite obscure to consumers. First, over-certification dilutes the
effective premium even during years in which the nominal FT premium is high. Then, the use of a
quality-invariant FT floor price in the very heterogeneous market for coffee creates a second,
completely unrelated mechanism through which producer benefit is eroded. We use unique data
from a large association of coffee cooperatives in Central America to measure nominal FT
premiums received by member cooperatives, comparing coffee of the exact same quality sold with
and without the FT label. We confirm that nominal premiums are dissipated by over-certification
and unrewarded quality differentials. In effect, FT membership is priced like a put option: producers
are willing to lose a small amount through participation during years in which the market price is
high in order to retain future access to the FT floor price. We conclude by discussing ways in which
the FT mechanism could be adjusted to take advantage of ethical consumers’ willingness to pay in
order to achieve the desired transfers of rents to smallholder producers.

It has been argued that the threat of regulatory intervention affects firm behavior. We investigate the pricing decision of the dominant firm under regulatory threat, considering the probability of intervention as a function of the price. Our focus is on the case where the potential divestiture of the firm serves as a threat of regulatory intervention. Specifically, we compare regulatory threat, which can be regarded as uncertain intervention, with deterministic intervention. It is shown that under certain conditions associated with the marginal expected penalty, regulatory threat induces the firm to lower prices even more than deterministic intervention. Numerical examples illustrate that with relatively small-scale divestiture, the firm’s price under regulatory threat may be lower than that under deterministic intervention within a relatively broad range of regulator’s attitudes toward intervention.