Preview of Class #4 (Part 2)

I described the game theory logic of “social dilemmas” or multi-player prisoners’ dilemmas in a previous post. In this follow-up post, let’s consider a specific example of a social dilemma: the problem of “climate change” or global warming. As the chart above shows, aviation is a significant source of greenhouse gas (GHG) emissions.[1] Commercial jets emit enormous amounts of carbon into the atmosphere. A single round-trip flight from London to New York, for instance, generates roughly the same level of emissions as the average person does by heating their home for a whole year.[2]

Imagine you are the CEO of American Airlines and that you are committed to protecting the environment. Also, assume there are no applicable U.S. or international laws regulating the levels of GHG emissions in the aviation industry. Lastly, let’s assume that you can reduce your emission levels in half if you reduce the number of long-haul flights or replace your airline’s fleet with smaller, more fuel-efficient aircraft or some combination of both strategies.

Unfortunately, when everyone else’s jets are emitting large amounts of greenhouse gases into the atmosphere, it is (in theory) a best response for you not to reduce your level of emissions as well because your airline’s lone decision to “go green” will only increase your costs of production and won’t save the environment, since everyone else in your industry is polluting anyways.

But even if everyone else in the airline industry has decided to “go green” and take costly steps to reduce carbon emissions (say, by reducing the number of flights or using smaller aircraft), it is still (in theory) a best response for you to defect, since you can gain a competitive advantage by doing so. Also, if you’re the only airline defecting, your airline’s carbon emissions alone won’t most likely create any catastrophic effects on the Earth’s temperature.

Alas, if too many people and firms behave selfishly–trying to maximize their own individual outcomes, for example–then everyone as a whole eventually suffers and we are all left with dirty air. Environmental law, however, might be able to promote cooperation in this domain by nudging every firm in the industry to reduce their emissions. Broadly speaking, there are three possible regulatory approaches when we confront a large-scale Prisoner’s Dilemma or social dilemma like aircraft GHG emissions. One approach is no regulation. Another approach involves direct regulation by imposing strict limits on the amount of emissions generated by each airline. Yet another possible approach is self-regulation via “cap-and-trade.” Let’s examine each approach in turn:

No Regulation

Although no regulation may seem absurd given the potential gravity of global warming, at the present time there is no direct federal regulation of aircraft emissions in the United States. In fact, no regulation is usually the default “solution” until Congress acts by enacting a law to address a given environmental problem.

Direct Regulation (“Command & Control”)

The standard proactive regulatory approach to a social dilemma, however, is “command and control” or direct regulation of the people and firms creating the problem. The EPA, for example, recently initiated a formal rulemaking process to “make a final determination on whether aircraft GHG emissions cause or contribute to air pollution which may reasonably be anticipated to endanger public health or welfare.”

If the EPA finds that aircraft emissions threaten public health, the EPA could decide to regulate aircraft emissions by imposing strict limits on the level of such emissions in much the same way that emissions from passenger cars and light trucks are regulated. In response to several oil price shocks in the early 1970s, for example, Congress enacted a law in 1975 authorizing the National Highway Traffic Safety Administration (NHTSA) to set fuel-economy levels or “Corporate Average Fuel Economy” standards for passenger automobiles and light trucks. The 1975 law called for a doubling of passenger-vehicle efficiency—to 27.5 miles per gallon (mpg)—within 10 years.[3]

Self-Regulation (“Cap and Trade”)

The European Union (EU), by contrast, has adopted a “cap-and-trade” or market approach to the aviation emission problem. The EU approach–which operates in the 28 EU countries as well as Iceland, Liechtenstein, and Norway–is called the Emissions Trading System or “ETS.” Under the cap-and-trade approach, the regulator first sets a maximum level or “cap” on the total amount of greenhouse gases or CO2 that airlines are allowed to emit from their flights per year. The regulator then allocates “pollution permits” or “allowances” to the airlines, granting each airline the legal right to emit a certain level of CO2 emissions per year. The total number of permits cannot exceed the cap, thus limiting total allowable CO2 emissions to the overall cap.[4]

An important feature of this system is that the pollution permits are tradeable. This means that an airline that reduces its emissions below its allowable level can sell its spare allowances to other airlines. Thus, if an airline’s emissions exceed the amount specified in its allocated allowance, it must either pay a substantial fine to the regulator or purchase a spare allowance from another airline to cover its emissions. Conversely, if an airline’s emissions are less than the amount specified in its allowance–that is, if an airlines ends the year with spare allowances–it can keep the spare allowances to cover its future needs or sell them to another airline that is short of allowances.

Conclusion

To sum up, whenever individuals or firms are trapped in a socially-destructive Prisoner’s Dilemma, legal rules backed by enforcement mechanisms or market devices can help us escape the dilemma by requiring (law) or encouraging (markets) the players to “do the right thing.” Of the major approaches we have discussed in this section, which one do you prefer and why?

End Notes

[1] See also Ian Waitz, et al., “Aviation and the Environment,” Report to the United States Congress (Dec., 2004).

[2] Source: http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm.

[3] Recently, the EPA and DOT released a joint notice of intent to formulate enhanced CAFE standards for cars and light trucks in model years 2017 to 2025. The EPA is currently considering a range of 47 to 62 mpg by 2025, or an annual fuel-economy increase of 3 to 6 percent. See EPA and DOT, Notice of Upcoming Joint Rulemaking to Establish 2017 and Later Model Year Light Duty Vehicle GHG Emissions and CAFE Standards, Notice of Intent (Washington, DC: EPA and DOT, Sept. 30, 2010).

[4] For an overview of the cap and trade approach to emissions control, see the EPA’s website: URL = http://www.epa.gov/captrade/basic-info.html.

About F. E. Guerra-Pujol

When I’m not blogging, I am a business law professor at the University of Central Florida.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s