The Rise and Fall of Polluter-Pays Principle in Developing Countries

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ContentslistsavailableatSciVerseScienceDirect

International

Review

of

Law

and

Economics

The

rise

and

fall

of

the

polluter-pays

principle

in

developing

countries

Barbara

Luppi

a,∗

_{, Francesco}

_Parisi

b,c

_{, Shruti}

_Rajagopalan

d

a_University_of_Modena_and_Reggio_Emilia,_Department_of_Economics_and_Center_for_Economic_Research_(RECENT),_Viale_Berengario_41,_Modena,_Italy

b_University_of_Minnesota_Law_School,_United_States

c_University_of_Bologna,_Department_of_Economics,_Italy

d_George_Mason_University,_Department_of_Economics,_United_States

a

r

t

i

c

l

e

i

n

f

o

Articlehistory:

Received7December2010

Receivedinrevisedform28August2011

Accepted17October2011 JELclassiﬁcation: K13 K32 Q56 Keywords: Environmentalprotection Polluter-paysprinciple Stateliability

a

b

s

t

r

a

c

t

Thepolluter-paysprinciplestipulatesthatthepersonwhodamagestheenvironmentmustbearthecost ofsuchdamage.Anumberofdevelopingcountrieshaverecentlyextendedthisprincipletocreatean obli-gationonthestatetocompensatethevictimsofenvironmentalharm.Thisvariationofthepolluter-pays principleisaimedatensuringvictims’compensationwhenpolluterscannotbeidentiﬁedorareinsolvent andatprovidingstrongerincentivesforlocalgovernments’monitoringofenvironmentallyrisky activ-ities.Theseregimesholdlocalgovernmentsprimarilyorjointly-and-severallyliableforenvironmental damageandallowthemtoactinsubrogationagainstthepolluters.Inthispaperwestudytheeffectof theseformsofgovernmentalliabilityonthepolluters’incentivesandonaggregatelevelsof environmen-talharm.Wedevelopaneconomicmodeltostudytheconditionsunderwhichgovernmentalliability maybepreferabletodirectpolluters’liabilityasaninstrumentofenvironmentalprotection.We con-cludebysuggestingthatthesevariationsofthepolluter-paysregimemaybedesirableinenvironments characterizedbywidespreadpoverty,highinterestrates,judicialdelaysanduncertaintyinadjudication. © 2011 Elsevier Inc. All rights reserved.

1. Introduction

Theideathatapollutershouldpayfortheenvironmentalharm

itcausesiswell-rootedinWesternlegalhistory.1_In_present_times,

thepolluter-paysprinciplestandsasaninternationalguidelinefor

environmentalpolicystipulatingthatthepersonorﬁrmwho

dam-agestheenvironmentmustbearthecostofsuchdamage.Since

anenvironmentalharmisoftenanexternality, liabilityinduces

theresponsiblepartytointernalizethefullsocialcostofhis

activ-ity,therebybringingtheenvironmentalharmdowntotheoptimal

level.Inthispaper,weshallconsiderarecenttrendobservedin

developing countries suchas India,Malaysia, Taiwan, Ecuador,

Chile,CostaRica,Kenya, and SouthAfrica, whoadopteda

vari-ation ofthepolluter-pays principlethrough judicial,legislative,

andconstitutionalreformsfocusedonmitigationofharmthrough

governmentalliability.Thesenewregimespurportedlyensure

vic-tims’ compensation when polluters cannot beidentiﬁed or are

∗ Correspondingauthor.

E-mailaddress:barbara.luppi@unimore.it(B.Luppi).

1_Already_in_a_celebrated_passage_by_Plato_we_ﬁnd_a_statement_of_the_principle

accordingtowhich:“Ifanyoneintentionallyspoilsthewaterofanother...lethim

notonlypaydamages,butpurifythestreamorcisternwhichcontainsthewater.”

TheDialoguesofPlato:TheLaws,vol.4,book8,section485(e),translatedbyJowett

B,Oxford:ClarendonPress(4thed.),1953.

insolvent. Reframing the original rationale of thepolluter-pays

principle,theseregimessuggestthattheprimaryaimisto

pro-videpromptcompensationtothevictimsofenvironmentalharm

andonlysecondarilytoimposeliabilityontheresponsible

par-ties.Inthelastfewdecadesseverallegalsystemshaverecognized

a primary obligation onlocal and central governments to

pro-videpromptreliefandcompensationtovictimsofenvironmental

harm.Werefertothisreinterpretationofthepolluter-paysregime

asthegovernment-paysregime.Localgovernments haveproven

quiteresponsivetothethreatofdirectliabilityandhaveboosted

theirmonitoringofenvironmentally-riskyactivitiestoavoidthe

ﬁnancialandpoliticaldisruptionassociatedwithanenvironmental

accident.

Thispaperisstructuredasfollows.InSection2weprovidea

briefhistoryofthepolluter-paysprincipleanditsrecent

reinter-pretationandtransformation,withspecialreferencetothecase

ofIndiaandotherdevelopingcountries.InSection3wedevelopa

modeltoconsidertheincentivesystemcreatedbyaregimeofdirect

governmentalliabilityonprospectiveinjurersandtoevaluatethe

effectsofthisregimeonaggregatelevelsofenvironmentalharm.

WedevelopaStackelberg-typegamewheregovernmentschoose

theirlevelsofpreventivemonitoringeffortandﬁrmschoosetheir

levelofcareinresponsetothegovernment’saction.Wecompare

thegovernment’smonitoringlevelsandtheﬁrms’carelevelsunder

thealternativepolluter-paysandthegovernment-paysregimes.

Weconsideralternativegovernmentalobjectivefunctionstoallow

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forbothbenevolentwelfare-maximizinggovernmentsand

shirk-ingcost-minimizinggovernments.InSection4,wecomparethe

polluter-paysandthegovernment-paysregimesinthepresence

oflegalandenforcementimperfections.Weconsiderthewelfare

propertiesofthegovernment-paysregime,comparingitseffectsto

thosethatwouldbeinducedbyabenevolent,welfare-maximizing

government.Section5considersthecomparativeadvantageofthe

tworegimesaseffectiveinstrumentsofenvironmentalprotection.

Section6concludeswithsomepolicyconsiderations.

2. Theriseandfallofthepolluter-paysprinciple

Academicshavelongrecommendedadoptionofthe

polluter-paysprinciplewhich wasthebasisof formalrecommendations

oftheOrganizationforEconomicCooperationandDevelopment

(OECD)sincetheearly1970s.2_The_extensive_work_of_the_OECD_over

thesubsequenttwodecadeswasresponsibleformetamorphosing

thiseconomicprincipleintoanestablishedlegalprinciple(OECD,

1992:9).Thepolluter-paysprinciplewasformallyadoptedbythe

EuropeUnionintheSingleEuropeanActof1987,3_and_in₁₉₉₂_was

recognizedbytheUnitedNationsConferenceontheEnvironment

andDevelopmentdelegates(so-calledRioDeclaration).4

Theimplementationofthepolluter-paysprinciplebysovereign

states has enjoyed different incarnations in national legal

sys-tems(Finn,1975).Insomesituations,thepolluter-paysprincipleis

implementedbystategovernmentsthroughdirectregulationthat

createseconomicincentives,leadingthepollutertobearthecostof

theenvironmentalharmcausedbyitsactivitythroughregulation

thatimposesdirectenvironmentalliabilityonthepollutingagents.

Inthecontextofenvironmentalliability,overthelastfewdecades

internationalandnationalenvironmentalliabilitylawshavebeen

invariablybasedonstrictliability(CommissionoftheEuropean

Communities,1993).Theproponentsofthestrictliabilityrulealso

focuson“costinternalization,”whichrequireschargingapolluter

forthesocialcost ofanactivity.5 _Furthermore,_liability_ensures

thatthepriceofcommoditiesreﬂectstheharmcausedby

non-negligentpollutingactivities,resultinginamoreefﬁcientallocation

ofresources(Krier&Stewart,1978).Underthenegligencerule,

non-negligentharmisnotinternalized,andtherecould,therefore,

beexcessiveentryofﬁrms,resultinginanincreaseinthe

probabil-ityofpollutionand/orenvironmentaldamage(Polinsky,1980).6_It

2 _The _Organization _for _Economic _Co-operation _and _Development _(OECD)

expressestheeconomicfunctionofthepolluter-paysprincipleasforcing“prices

ofgoods(dependingonthequalityand/orquantityofenvironmentalresources)

toreﬂect,moreclosely,theirrelativescarcityandthateconomicagentsconcerned

reactaccordingly”(OECD,1972;OECD,1974).

3 _Single_European_Act,₁₇_February_1986,₁₉₈₇_O.J._(L_169)._Article₁₇₄₍₂₎_of_the

consolidatedversionsoftheTreatyonEuropeanUnionandoftheTreatyEstablishing

theEuropeanUnion,2002O.J.(C325)1providesthat:“Unionpolicyonthe

envi-ronmentshallaimatahighlevelofprotectiontakingintoaccountthediversityof

situationsinthevariousregionsoftheUnion.Itshallbebasedontheprecautionary

principleandontheprinciplesthatpreventiveactionshouldbetaken,that

envi-ronmentaldamageshouldasapriorityberectiﬁedatsourceandthatthepolluter

shouldpay.”

4 _Principle₁₆_of_the_Rio_Declaration_provides_that:_{“[n]ational}_authorities_should

endeavourtopromotetheinternalizationofenvironmentalcostsandtheuseof

economicinstruments,takingintoaccounttheapproachthatthepollutershould,

inprinciple,bearthecostofpollution.”

5 _This_is_consistent_with_the_economic_rationale_of_the_{polluter-pays}_principle,

whichmandatesthecost-internalizationprinciple(Bergkamp,2001).SeealsoOtt

andSchäfer(1996,2004).

6 _The_economic_rationale_for_this_is_that_strict_liability_is_a_preferable_rule_in

sit-uationsofunilateralcareandwhereonlytheinjurercantakeeffectiveprecautions

topreventtheharm.Further,whilebothstrictliabilityandnegligencerulesinduce

theinjurertotaketheoptimalamountofcare,theadvantageofstrictliabilityin

environmentalcasesisthatonlytheharmmustbeobservable.Thelevelofcareis

irrelevantandthereforeneednotbeestablishedinacourtoflaw,therebyreducing

evidentiaryrequirements.Theotherreasonfortheincreaseduseofstrictliability

shouldbenotedthat,whileitistruethatmanycountriesembracea

strictpolluter-paysprinciplewithrespecttoprohibitedemissions,

severalcountriescontinuetotreatpermittedpollutionaslargely

free.7

2.1. Recentdeparturesfromthepolluter-paysprinciple

Incasesofenvironmentalpollutionanddegradationin

devel-opingcountries,adifferentvariationofthepolluter-paysprinciple

emergedfocusedprimarilyontheneedtoprovideimmediate

com-pensationtovictimsofenvironmentalharm.8_Through_legislation

andjudicial precedents,a number ofcountrieshavecreatedan

obligationonlocalgovernmentstoprovidedirectandprompt

com-pensationtothevictimsofenvironmentalharm.9 _These_judicial

andlegislativereinterpretationsofthepolluter-paysprinciplehold

statesandlocalgovernmentsjointly-and-severallyliableforthe

environmentaldamagecausedbyprivateparties,allowingthese

publicbodiestoactinsubrogationagainsttheindividualpolluters

when possible. Thisvariant of thepolluter-pays principle

gen-erally seesa primary rolefor localand central governmentsto

providecompensationtovictimsofenvironmentalharm.This

vir-tuallysubvertsthelogicoftheprinciple bysuggestingthatthe

primarygoalis toprovideprompt compensationtothevictims

ofenvironmentalharm,andonlysecondarilytotransfertheloss

throughsubrogationontheresponsibleparties.Thisquite

dras-ticshiftawayfromthestrictliabilityregimeofthepolluter-pays

principleismotivatedbytheneedtocreatedirectmonetary

incen-tivesonlocalenvironmentalagenciesaugmentingtheirincentives

toengageinmonitoringofactivitiesthatcreatepotentialriskforthe

environment.

Thewisdomofthesereformsliesintheideathatlocal

govern-mentsrespondparticularlytothreatsoflitigationandpossessthe

necessaryadministrativeandlegalinstrumentsfortheeffective

monitoringofprospectivepolluters.Fiscalrevenuesheavily

con-strainthebudgetsoftheselocalgovernmentsandenvironmental

agenciesand,ifheldliablefor thedirectcompensationof

envi-ronmentalharm,theseentitiesfaceapossiblydisruptiveshortfall

withbothpoliticalandﬁnancialconsequences.Unlikeinsurance

companies, local governments transmit the care incentives to

potentialpolluters,notonlythroughthethreatofsubrogation,but

alsothroughseveralotheradministrativeinstruments(permits,

safety and emission controls, site inspections, etc.) and legal

inenvironmentprotection,especiallyinanagewhereallgovernmentsaretrying

tocurbindustrialpollution,isthatinamarketsetting,negligencemayprove

inefﬁ-cientcomparedtostrictliability,inasmuchasitdoesnotcreateadequateincentives

toreduceactivitylevelsandtoinvestinresearchanddevelopmentofnewcleaner

technology.

7_Member_states_of_the_EU_are_still_far_from_shifting_the_entire_cost_of

environ-mentaldegradationonpollutingﬁrms.Forexample,withthepossibleexceptionof

Sweden,memberstateshavenotdevelopedacomprehensivesetoffeeson

per-mitteddischarges.Thepolluter-paysprinciple,therefore,onlyappliesuniformly

acrosstheEUtoimplythatallprohibitedandharmfuldischargeshouldbepaidfor.

Theextenttowhichthecostofpermittedpollutionistransferredontoactual

pol-lutersinsteadvariesacrossmemberstates.Thisisinmanywaysshortofwhatafull

implementationofthepolluter-paysprinciplewouldrequire(Faure,2009).

8_Pigouvian_taxation_instruments,_involving_a_direct_tax_on_every_unit_of_pollution

oroneveryunitproducedbythepollutingactivity,havealsobeenconsideredas

alternativeimplementationsofthepolluter-paysprinciple.Athirdwayinwhich

thepolluter-paysprinciplehasbeeninterpretedandimplementedbynational

gov-ernmentsisthroughtheadoptionofmarket-basedinstruments,suchaspollution

permitsandbubble-typepollutionallowances.Inyetothersituations,government

interpretsthepolluter-paysprinciplebroadlyandimplementitthrough

command-and-controlmeasureswhereinthegovernmentmayspeciﬁcallyprohibitcertain

environmentallydangerousactivitiesordisallowcertainproducts,methods,or

sci-entiﬁctechniques.

9_Faure,_Goodwin,_&_Weber₍₂₀₁₀₎_point_out_the_importance_of_optimal_design_of

environmentallawindevelopingcountry,rathertoimportNorthernregulation,in

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threats(ﬁnes,revocationandsuspensionoflicenses,etc.).10_These

instrumentscanmakethemonitoringactivityoflocalgovernments

particularlyeffective.

2.2. Fromthepolluter-paystothegovernment-paysprinciple:

thecaseofIndia

Indiahasundertakenatranformativeapproachto

environmen-talprotectioninrecentyears,atboththeregulatoryandjudicial

level(Faureetal.,2010).11_Recent_developments_in_{environmental}

protectioninIndiaexamplifyareinterpretingofthepolluter-pays

principlein themethoddiscussed above(Jaswal,2008).12 _India

recentlyadoptedasystemofdirectgovernmentalliability

requir-ingthestatetopaydamagestothevictimofenvironmentalharm

andallowingthegovernmenttorecoveritsdisbursementsfrom

thepolluteratalatertimethroughanactionforsubrogation.13

TheStockholmDeclarationin1972providedatouchstonefor

Indian environmental legislation. India agreed with 113 other

nations on principles and plannedto protect the environment

resultinginanobligationtoimplementthesedomestically.Inthe

fulﬁllmentoftheobligationsarisingfromtheStockholm

Declara-tion,Indiawitnessedaproliferationofenvironmentallawsand

reg-ulations.Inkeepingwithinternationalstandards,theIndian

gov-ernmentenactedlegislationforenvironmentalprotection,water

pollution,airpollution,andwildlifeconservation.Mostnotably,the

implementationoftheStockholmDeclarationledtothe

amend-ment of the Indian Constitution,14 _which _incorporated _Articles

48A15 _and _Article_51A(g).16 _On_the_basis_of _these_{constitutional}

provisions,theIndianParliamentenactedtheWaterAct,1974,the

AirAct,1981,andtheEnvironmentalProtectionAct,1986(Krishna

Kumari,2007).Inconjunctionwiththeseregulations,Indiacreated

specializedauthoritieswithagrantofwidepowersincluding

clo-sureofindustriesandthepowertogiveanydirectionstoprotect

theenvironment.17_Yet_these_authorities_suffer_from_{administrative}

failuressimilartothoseplaguingtherestoftheIndianbureaucracy

andexecutive.CitiesandriversinIndia,inparticular,underwent

unprecedenteddegradation.Withrisingenvironmental

degrada-tion,theincreasinglyactivistIndianjudiciarybegantotakegreater

noteofthesestandards,creatinganobligationonstate

govern-mentstoprovidecompensationtothevictimsofenvironmental

harmthathasnotbeensuccessfullypreventedbytheproactive

precautionarymeasuresofthespecializedauthorities.

The Indian judiciary took special interest in this matter on

counts of social justice, since most of the victims of such

10_See_also_Nash₍₂₀₀₀₎_,_Schäfer₍₂₀₀₀₎_and_Guelton₍₂₀₀₂₎_.

11 _See_also_OECD_(1972,_1974,_1989,₁₉₉₂₎_and_Babu,_Eger,_Raja,_Schäfer,_and Somashekhar(2010).

12 _Further_analysis_of_the_various_legislation_and_{environmental}_cases_can_be_found

inJaswal(2008),whichhasprovidedacomprehensivesourceofinformationfor

thissection.TheWorldBankhaspredictedthatIndia’swater,air,soil,andforest

resourceswillbeundermorehumanpressurethanthoseofanyothercountryby

theyear2020.

13 _Faure_and_Raja₍₂₀₁₀₎_discuss_on_the_{effectiveness}_of_{environmental}

regula-tioninIndia,withspecialreferencetopublicinterestlitigation.SeealsoCraigand

Deshpande(1989),Prasad(2004)andRajaandRathinam(2005).

14 _See_Bakshi₍₂₀₀₅₎_and_Jain₍₂₀₀₅₎_for_studies_on_the_Indian_{Constitution.}

15 _Article_48A_is_a_Directive_Principle_guiding_the_state_for_the_{“protection}_and

improvementofenvironmentandsafeguardingofforestsandwildlife.”

16 _Article_51A(g)_is_a_Fundamental_Duty_for_the_citizens_of_India_to_“protect_and

improvethenaturalenvironment.”

17 _The_Central_Pollution_Control_Board_(CPCB)_and_State_Pollution_Control_Boards

(SPCBs)wereinitiallysetupundertheprovisionsoftheWaterAct,1974,andnow

alsocarryouttheirfunctionsundertheAirAct,1981.TheCPCBandtheSPCBsalso

performalladditionalfunctionsundertheEnvironmentalProtectionActandare

theprimeenvironmentalauthoritiesinIndia.Theyaresupportedbytherelevant

authoritiesforthesupervisionofcoastalzoneregulations:theNationalCoastalZone

ManagementAuthorityandStateCoastalZoneManagementAuthorities.

environmentaldegradation had nopossible meansof

individu-allysuingthepolluters toenforcethepolluter-paysprinciple.18

In several instances, the Supreme Court issued orders to the

relevantmunicipalauthority toconstitutemechanismstoclean

environmentaldamageandcompensatevictimsofpollution,

giv-ing the municipal authority an option to act in subrogation

against the responsibleparties. Evenwhen an action was

suc-cessfully brought against the polluting ﬁrm, it was established

that the government would remain liable to pay for residual

shortfalls.19

Asaresultofthesedevelopments,stateauthoritiesnowplay

amuchlargerrole.Thestateisnowinvolvedinall

environmen-talmatters,fromcreatingtheappropriateauthoritytocleanthe

environmentpollution,toactuallysteppinginforthepolluterand

payingdamages.Manylaudthismodelofgovernmentalliabilityfor

environmentalharm(thegovernment-paysregime)asthesavior

ofIndia’secology.

2.3. Theadoptionofthegovernment-paysprincipleinother

developingcountries

Similar incarnations of the government-pays principle have

beenobservedinahandfulofotherdevelopingcountries,especially

whereongoingeconomicdevelopmentputsseverepressureonthe

environment.CountrieslikeMalaysia,Taiwan,Ecuador,Chile,Costa

Rica,SouthAfrica,andKenyaadoptedremediesfocusedon

miti-gationoftheharmthroughgovernmentalliability.Thesesystems

carriedoutreformsthroughjudicial,legislativeandconstitutional

intervention,toensurevictims’compensationwhenpolluters

can-notbeidentiﬁedorareinsolvent.

SimilartothecaseofIndia,theseregimessubvertedtheoriginal

rationaleofthepolluter-paysprinciple,imposingongovernments

and localagenciestheobligationtoprovideprompt

compensa-tiontothevictimsofenvironmentalharm,andonlysecondarily

torecovercostsfromtheresponsibleparties.

Withinthiscontext,inthelastfewdecadesTaiwanwitnessed

much citizen activism leading tothe recognitionof a principle

which entitlesvictimstoreceive governmentcompensationfor

pollution.The1986protestagainstpollutionbyDuPontandthe

1988protestagainsttheLunyuanIndustrialZonecausinglivestock

deathsduetopollutionspurredthegovernmentintoaction.The

latterofthetwocausestookproteststotheextentofviolenceand

thegovernmentcompensatedthevictimsbyproviding$10million.

Insubsequentyears,protestersralliedagainstTaipowerandChina

PetroleumCompany,leadingtoasettlementofupto$250million

(Chen,1994).

AnotherinterestingexamplecomesfromtheMalaysian

Envi-ronmentalQualityAct.TheDirectorGeneralofMalaysiahaspowers

verysimilartohisIndiancounterpart.UnderSection47(1)ofthe

Environmental QualityAct,theDirectorGeneralmaytakesuch

actionnecessarytoremove,disperse,destroyormitigatethe

pol-lutionandmayrecoverfromthepolluterallcostsandexpenses

incurredinconnectiontherewith(Mustafa,1991).

18_Although_Indian_law_recognizes_a_class_suit_or_a_{representative}_suit,_wherein_one

ormoremembersofaclasshavingthesameinterestmaysueordefendonbehalf

ofthemselvesandalltheothermembersoftheclass(Order1Rule8oftheCivil

ProcedureCodeof1908),fewcasesusedtheseactionsandwithlittlesuccessand

werenotregardedasaviablesolutiontotheproblemathand.

19_For_example,_in_the_Bhopal_Gas_Tragedy,_after_ﬁve_years_of_litigation,_an

out-of-courtsettlementwasreachedbetweenthepollutingcompany,UnionCarbide,and

theGovernmentofIndia.TheSupremeCourtheldthatifthesettlementfundthat

hadbeennegotiatedwasexhausted,theGovernmentofIndiashouldmakegood

thedeﬁciencyforallthepast,presentandfutureclaimsarisingfromthegasleak.

BhopalGasLeakDisaster(ProcessingofClaims)Act,1985.UnionCarbideCorporation

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SouthAfricaand Kenyaexemplify twosimilardevelopments

fromthe African continent (Bruch, Coker, & VanArsdale, 2001;

Mustafa, 1991; Rabie, 1991). In the late 1980s South Africa

witnessedashifttowardsgovernmentcompensationfor

environ-mentalharmcausedbyprivateinjurers,whichledtolegislative

intervention.Section19oftheEnvironmentalConservationAct73

of1989empowersthegovernmenttotakethenecessarystepsto

repairthedamageandtorecoverthecostfromthepolluterforits

failuretotakeadequatemeasures(Rabie,1991).20_Following_the

footstepsofSouth Africa,in2002Kenya drafteda provisionfor

citizenredressagainstpollutionfromtheHighCourtinitsDraft

Constitution.Ifpassed,thisprovisionwouldempowercitizensto

directlyapproachthecourttoenforcetherighttoaclean

environ-ment(muchlikethejudicialinterpretationreadintoArticle21of

theIndianConstitution).Theprovisiongivesextensivepowersto

thecourttocompelthegovernmentoranypublicagencytotake

restorativemeasuresandtoprovidecompensationforanyvictim

ofpollutionandtocompensatethecostbornebyvictimsforthe

lostuseofnaturalresourcesasaresultofanactofpollution.21

Wealsoobservesimilardevelopmentsthroughlegislativeand

judicial intervention in South American countries. In the

Fun-daciónNaturacontraPetroEcuadorcase,anEcuadoriancourt,when

approachedbyanenvironmentalactivistNGO,orderedthestate

agency to assess the damage and to compensate the

commu-nity,holdingthat thestatecould suethecorporation oncethe

assessmentwascompleted.22_In_Chile,_the_Framework_Law

con-tainsprovisionsforcitizen-suitstoredressenvironmentalharm.

The law allows individuals to commence legal actions against

localgovernmentstorecoverforenvironmentaldamages(Sullivan,

1996).Itprovidesthatvictimsofenvironmentalharmmayrequire

themunicipalityinwhichtheactivitydamagingtheenvironment

occurredtoactontheirbehalf,holdingthemunicipalityjointlyand

severallyliablefortheenvironmentaldamagewhichthepetitioner

hassufferedincaseofgovernmentinaction.23_Similarly_Costa_Rica

penalizesgovernmentinactionthroughtheOrganic Lawforthe

Environment(1995).Itgivestheauthoritythepowertoissue

warn-ings,admonitions,restrictionofanydamagingactivity,partialor

totalclosingorfacilities,partialortotalcancellation ofpermits,

patents,certiﬁcationofincorporationincaseofnonfulﬁllmentof

theauthority’sorders.Thelawgoesastepfurtherandprovidesthe

abovesanctionsforgovernmentofﬁcialswhoviolatethelawsand

regulationsforactionoromission(Santos,1996).24

20 _Section₁₉_and₂₀_{Environmental}_Conservation_Act₇₃_of_1989.

21 _Article_241,_Chapter_12,_Draft_Constitution_of_the_Republic_of_Kenya_2002.

22 _Fundación_Natura_contra_Petro_Ecuador_de_la_Provincia_de_Buenos_Aires,_Expediente

No.221-98-RACorteConstitucionaldeEcuador,1998),upholdingFundaciónNatura

contraPetroEcuador,ExpedienteNo1314(Juzgadodecimoprimerodelocivilde

Pichincga,April15,1998).

23 _Framework_Law,_Tit._III,_Art._54.

24 _Although_the_trend_towards_the_{government-pays}_regime_is_a_frequent

phe-nomenonin developingcountries, someindustrialized countriesalso provide

scatteredexamplesofstatefundsforenvironmentalprotection,mostnotablyin

theUnitedStates,JapanandFrance(Cole,1991;Lin,2005).Thesepiecesof

regu-lationareratherexceptionalinnatureand,asnotedbelow,representvariations

ofthepolluter-paysprinciple,ratherthananembodimentofthegovernment-pays

principleobservedindevelopingcountries.IntheUnitedStates,the

Comprehen-siveEnvironmentalResponse,Compensation,andLiabilityActof1980,(CERCLA)

isthemainfederallawoftheUnitedStatesthataddressestheclean-upof

haz-ardoussubstances.TheSuperfundcreatedundertheActintendedtopayforthe

cleanupofhazardous-wastedumpsitesandspills,ﬁnancedbyacombinationof

generalrevenuesandtaxesonpollutingindustries.TheEnvironmentalProtection

Agencywasdirectedtocreatealistofthemostdangeroussites;itwouldthen

compelthepollutertopayforthecleanuporwouldpayforthecleanupitself

throughtheSuperfundandsueforreimbursement.Precedingthissweeping

leg-islationwastheDeepwaterPortActof1974whichheldtheownersandoperators

ofvesselsstrictlyliablefordamagescaused.HowevertheDeepwaterPortLiability

Fundwascreatedtobeliablefordamagesandthecostofcleaningtheenvironment

whensuchclean-upwasnotcompensatedbytheprivatepolluter.In1973,France

InSection3,wewillanalyzetheincentivesystemcreatedby

thisregimeofgovernmentalliabilityforprospectiveinjurersand

itseffectontheaggregatelevelofenvironmentalharm.

3. Modelinggovernment’sandpolluters’incentives

Inthissection,wepresentaformalmodeltocomparethe

incen-tiveand welfareeffectsoftheenvironmentalliabilityprinciples

consideredabove.InSections3.1and3.2,wewillidentifysomeof

thebasicfeaturesofthisregimewithrespecttogovernment’sand

polluters’incentives.

Under eachenvironmentalprinciple,thegovernmenthasan

incentivetomonitorexantetheenvironmentallydangerous

activ-ities of private individuals and ﬁrms. Individual ﬁrms have an

incentivetoundertakecarein ordertominimizethelikelihood

ofanaccident.WedevelopaStackelberg-typegamewhere

gov-ernmentschoosetheirlevelsofpreventivemonitoringeffortinthe

ﬁrststageandﬁrmschoosetheirlevelofcareinthesecondstage

ofthegame.Parties(governmentandpolluters)areassumedtobe

riskneutral,rational,andutilitymaximizing.

Inthefollowingwecharacterizetheoptimalmonitoringlevel

of thegovernment and the optimalcare level of an individual

ﬁrmunderthealternativepolluter-paysandthegovernment-pays

regimes. We describe the effects of the polluter-pays and the

government-paysregimes,identifyingtheconditionsunderwhich

oneortheotherisamoreeffectiveinstrumentofenvironmental

protection.25

3.1. StartingfromStage2:thecarechoiceofprospectivepolluters

We assume that the principal’s (government) best strategy

incorporates the agent’s (prospective polluter) best reactionto

thegovernment’saction.Using backwardinduction,westartby

identifyingtheagent’s choice.Theagentcarriesoutan activity,

withaﬁxedvalueV,26_that_may_cause_{environmental}_harm._The

agentcaninvestincaretoreducetheprobabilityof

environmen-talharm.Denotewithxtheagent’slevelofcare,wherex∈[0,∞(.

Withalevelofcarex,environmentaldamageoccurswith

proba-bilityp(x),wherep(x)∈(0,1).Weassumeunilateralcare,suchthat

theprobabilityoftheenvironmentaldamagecanonlybe

effec-tivelycontrolledbythepolluter’slevelofcare.Thegovernment

canaffectthepolluter’slevelofcarethroughmonitoringbut

can-notdirectlyreducetheenvironmentalriskbytakingprecautions

onitsown.Likewise,thevictimsbeartheharmwithoutbeingable

toreducetheprobabilityofitsoccurrencewiththeirown

precau-tions.Weassumethattheagent’scaredecreasestheprobabilityof

environmentaldamage,px<0,atadecreasingrate,pxx>0.When

allocatedenvironmentaldamagefundstocontrollingnoisepollution.InJapan,the

1967BasicLawforEnvironmentalPollutionControlisthebedrockforallthe

legisla-tionthatfollowedtoprotectboththeenvironmentandpollutionvictims.Inkeeping

withtheEuropeantrendstheJapanesegovernmentenactedlawstoprotectairand

water,regulatetheproductionofchemicalsubstances,andconserveandprotect

thenaturalsurroundings.TheJapanesegovernmentcreatedtwotypesof

compen-sationstructuresundertheLawfortheCompensationofPollution-RelatedHealth

Injuries.Theﬁrstfollowsthepolluter-paysprincipleandmandatesthatvictimsbe

compensatedbytheprivateinjurer.Andasecondcategoryofvictimsarethose

whoseinjuriescannotbetracedtospeciﬁcpollutersandarecompensatedbythe

Pollution-RelatedHealthDamageCompensationAssociation,ﬁnancedbypollution

levies(Gresser,Fujikura,&Morishima,1981).Thecompensationsystemadoptedin

Japanusestaxescollectedfromemissionstopaycompensationtovictims,hence

representingaPigouvian-taxvariationofthepolluter-paysprinciple,ratherthanan

applicationofthegovernment-paysregime.

25_For_a_recent_analysis_of_the_tradeoff_between_direct_and_indirect_incentives_in

thecontextofstateliability,seeDari-Mattiacci,Garoupa,andGomez-Pomar(2010).

26_The_assumption_of_a_ﬁxed_level_of_activity_increases_analytical_tractability_and

resultsdonotdependonthisassumption.Resultswithavariableactivitylevelare

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environmentaldamageoccurs,anexogenouslossdenotedbyLis

created,whereL>0.Inthesimpleeconomyconsideredhere,there

aretwotypesofagents(potentialpolluters),i=R,P.Richagents,R,

arecharacterizedbythefactthattheyhavealevelofwealthAR

suf-ﬁcienttocompensatefortheenvironmentalharmLcausedbytheir

activity.Pooragents,P,havealowerlevelofwealth,denotedbyAP,

whereAP<L.Itfollowsthatinthisframework,thedamagespaidby

atype-RagentequalthelossL,sinceAR≥L,whilearepresentative

type-PagentwillpaydamagesequalatmosttohiswealthlevelAP,

sinceAP<D.Weshallrefertoiastheproportionoftype-iagents

inthepopulation,i=R,P.27

Eachprospectivepolluterchoosesthelevelofcaretominimize

theexpectedcostofliabilityandprecautioncosts.28_{Additionally,}

thegovernmentcanengageinmonitoringoftheﬁrms’activities

throughexantesafetycontrolsandsanctionsthatimposeacost

onﬁrmsthatdeviatefromthesociallyoptimallevelofcare.The

governmentisassumedtoimposeaperunitcostondeviatingﬁrms,

equaltom(e).

Theobjectivefunctionforaprospectivepolluteriis:

min{x_i}p(xi)Di+xi+m(e)(x∗∗−xi) (1)

Proposition1. Theprivatelyoptimallevelofcarechosenbytype-P

agentsislowerthanthelevelofcarechosenbytype-Ragents:x∗_P≤x∗_R.

Type-Ragentsexertthesociallyoptimallevelofeffort.

Proof:SeeAppendixA.

Thisresultshouldnotbesurprising.Thelimitedwealthoftype-P

agentsreducestheirexpectedliability,hencediminishingthe

(pri-vate)marginalbeneﬁtofcare.Type-Pagentswill,therefore,havea

lowerincentivetoinvestincare(Dari-Mattiacci&DeGeest,2005;

Shavell,1986,1987).Onthecontrary,fullyliableagentswillexert

thesociallyoptimallevelofcare.

3.2. Stage1:themonitoringdecisionofthegovernment

Havingidentiﬁedthebestreactionofprospectivepolluters,we

canidentifythegovernment’sbestmonitoringstrategythrough

backwardinduction.Wedosobyconsideringthegovernment’s

decision under the polluter-pays regime and the

government-pays regime. When investing to contain environmental harm

through monitoring, the government faces a monitoring cost,

whichdependsontheeffortlevel,e∈[0,∞(.Thiseffortlevelshould

be thought as the incremental monitoring effort of local

gov-ernmentsandenvironmentalagenciesinresponsetotheriskof

environmentalharmandthethreatofdirectliability.29

Thegovernmenthasinformationontheﬁnancialwealth,Ai,i=R,

P,oftheagentsandcanundertakedifferentmonitoringlevelsfor

thetwotypesofagents.Themonitoringexpenditureequalsthe

totalmonitoringeffortexertedonrichandpooragents,whereei

denotestheeffortperindividualtypeofagent,i=R,Pand␥idenotes

thefractionofthepopulationoftypei,i=R,P.

3.2.1. Benevolentgovernment

Theobjectivefunctionofabenevolentgovernmentisto

mini-mizetheexpectedenvironmentalloss,themonitoringcostandthe

carecostsofeachtypeofagent.

min_(e

i)i=R,Pp(xi)iL+

i=R;P

i(c(ei)+xi) (2)

27 _Without_loss_of_generality,_the_size_of_the_population_is_normalized_to_one_and

R+P=1.

28 _This_is_equivalent_to_the_problem_of_maximizing_the_agent’s_objective_function

equaltothevalueofactivitynetoftheexpectedliabilityandprecautioncosts,due

totheassumptionofﬁxedactivitylevel.

29 _This_is_compatible_with_a_ﬁxed_monitoring_level_on_each_type_of_agent.

Proposition2. Abenevolentgovernmentundertakesahigherlevel

ofmonitoringfortype-Pagentsthanfortype-Ragents:eSO

P >eSOR .The

levelofcarechosenbytype-Pagents,however,islowerthanthelevel

ofcarechosenbytype-Ragents:xSO

P <xSOR .

Proof:SeeAppendixA.

3.2.2. Introducingimperfectgovernments:therelevanceoflegal

regimes

When the incentives of government ofﬁcials misalign with

thoseofthecommunity,thegovernmentmayexperienceagency

problems.Inchoosingtheircourseofaction,governmentofﬁcials

maynot perfectlyinternalizethesocial losscaused bya

pollu-tionaccident, equal toL.Giventheimperfectinternalizationof

theaccidentloss,thegovernment’smonitoringeffortwillbe

sub-optimal.Theintroductionofgovernmentalliabilityremediescan

correctthedilutionofincentivescausedbyagencyproblems.Under

agovernment-paysregime,government’s monitoringlevelswill

reﬂecttheresiduallossborne bygovernments unabletocollect

damagesfrominsolventordisappearingpolluters, L−AP.Under

a government-paysregime, thewelfarefunctionof the

govern-mentisequaltothesumofaweightedaverageofthesocialloss

(weightedby˛)andthegovernmentﬁnancialloss(weightedbyˇ)

andthemonitoringandcarecosts.Analytically,thewelfare

func-tionofthegovernmenttakesthefollowingform:

min_(e

i)i=R,Pp(xi)i[˛L+ˇ(L−min{L,Ai})]+

i=R,P

i(c(ei)+xi) (3)

Agency problems in governmental action are present when

˛≤1.Thewelfarefunctioncollapsestotheoneofabenevolent

governmentwhen˛=1andˇ=0.Wecannowstudythe

monitor-ingincentivescreatedbytheapplicationofthegovernment-pays

regimeonthetwotypesofagentsconsideredabove.

AsdiscussedinSection2,inagovernment-paysregime,allcases

ofenvironmentaltortsandenvironmentalaccidentscanbeeither

ﬁledthrough publicinterestlitigationdirectlyagainststateand

localgovernmentsorbroughtagainstthesegovernmentalbodies

throughjoint-and-severalliabilityactionsintorts.30_In_either_case,

thedeterminedamountofdamageswillbepaidbythestatetothe

victims.Thestatehasanopportunitytoactinsubrogationagainst

theactualpolluterstorecoverdamagespaidtothevictimsandthe

costofenvironmentalrestoration.

Intheseregimesofgovernmentalliability,primaryliabilityfor

environmentaldamage caused byprivate ﬁrmsand individuals

fallsonthestateand localgovernments. We assumethat local

governmentsandenvironmentalagenciesareconstrainedby

ﬁs-calrevenuesandrespondtothethreatofprimaryliability,which

wouldcauseﬁnancialdisruptionwithpoliticalandelectoral

con-sequences.

Underthegovernment-paysprinciple,weassumethatthe

gov-ernment’srightofsubrogationtransfersthelosstotheresponsible

partyonlytosolventparties,butleavesthelossonthe

govern-mentincaseofinsolvency.Underthegovernment-paysprinciple,

weassumeˇ≥1,i.e.thegovernmentfullyinternalizestheportion

ofthedamagecompensationpaidouttoenvironmentalvictims

andfacescostforadministeringsuchfunds,sincethegovernment

bearsnotonlytheportionofthelossunrecoverablefrom

insol-ventparties butalsolegalandadministrativecosts.Weassume

thatunderthepolluter-paysprincipal,thegovernmentdoesnot

fullyinternalizethevictims’loss(ˇ<1),whenthevictimremains

uncompensatedduetoinsolvency.

30_In_the_case_of_{environmental}_protection_in_India,_this_involves_ﬁling_a_writ

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Proposition3. Theintroductionofgovernmentalliabilityleadstoan

increaseofthemonitoringoftype-Pagents.Themonitoringexherted

ontype-Ragentsisnotaffectedbythechoiceoflegalregime.

Proof:SeeAppendixA.

Proposition4. Themonitoringexhertedontype-Pagentsunderthe

government-paysregimemayexceedthelevelchosenbyabenevolent

government,i.e.e∗_P>eSO

P ,forsufﬁcientlyhigh˛andˇ.

Corollary. In agovernment-pays regime, type-P[type-R]agents

undertakeahigher[lower]levelofcarethanwhatwouldbechosen

whenmonitoringiscarriedoutbyabenevolentgovernment:xSO

R >x∗R

andxSO

P <xP∗forsufﬁcientlyhigh˛andˇ.

Proof:SeeAppendixA.

The government-pays regime may trigger an overshooting

of monitoring incentives with respect to type-P agents. This

overshootingeffectresultsfromthefactthatthegovernment

inter-nalizesthebeneﬁtofitsmonitoringbutdoesnotfullyinternalize

aportion(equalto1− ˛)ofsociallossLandthehigher

precau-tioncoststhatagentsface.7).Weobserveexcessivemonitoringof

type-Pagentsinanumberofsituations.Forexample,thisoccurs

wheneverthegovernmentweighsconsistentlymoreitslossthan

thesocialloss(i.e.ˇ>1ifAP=0andˇ> ¯ˇ >1ifAP>0),orwhen

thegovernmentfullyinternalizesthesocialloss,butfacesalsoa

lossatthestageofsubrogation(ˇ>0for anyAP≥0).Arational

governmentwillengageinstrictermonitoringoftype-Pagentsin

ordertoreduceitsexposureinthefaceofinsolventtortfeasors.This

maytriggerhigher(andpossibly,excessivelyhigh)levelsofcareby

type-Pagents.

Comparingthe effects of monitoringon thelevel of care in

Propositions 2 and 4 yields an intriguing result. As stated in

Proposition2,whenmonitoringiscarriedoutbyabenevolent

gov-ernment,type-Pagentswillchoosealowerlevelofcarethanthe

levelofcarechosenbytype-Ragents:xSO

P <xSOR .Thisresultruns

contrarytotheobservationinProposition4inthe

government-paysregime,wherex∗_R<x∗_P.Governmentalmonitoringoftype-P

agentsremainshighinallcases,butthemonitoringcarriedoutby

awelfare-maximizinggovernmentdoesnotleadtotheparadox

observedinProposition2,wheretype-Pagentstakehighercare

thantype-Ragentsinspiteoftheirlimitedliability.Abenevolent

governmentwillinducelowercarelevelsfortype-Pagentsthanfor

type-Ragentsbecausetheprecautionsoftype-Pagentsaresocially

morecostlythanthoseoftype-Ragents.Althoughdirectprecaution

costsarethesamefortype-Pandtype-Ragents,theinducementof

precautionsfortype-Pagentsnecessitatehighermonitoringcosts

giventhereduceddirectincentivestheyfacebecauseoftheir

lim-itedliability.

3.3. Summaryresults

InTable1,wesummarizetheresultsofthepreviousanalysis

evaluatingtheefﬁciencyofthelevelsofcareandgovernmental

monitoringfortype-Pandtype-Ragentsinthegovernment-pays

regime.Wedosobycomparingthelevelsofmonitoringandcare

inagovernment-paysregimetothosethatwouldbeinducedbya

benevolentgovernment,asdiscussedinSection3.2.1.

Intuitively,inbothregimestype-Pagentsaremonitoredmore

closelythantype-Ragents.Infact,inbothregimes,type-Pagents

face reduced direct incentives through liability and necessitate

highergovernmentalmonitoring.Theextentofmonitoringof

type-Pagents,however,differsbetweenthetworegimes,eSO

P <e∗P.

Thisbringstolightanimportanteffect.Itispossibletoseethatin

thegovernment-paysregime,governmentalmonitoringmaylead

toanovershootingincareincentives,inducingtype-Pagentsto

adopthigherlevelsofcarethantype-Ragents,x∗_R<x_P∗.This

over-shootingeffectisnotobservedunderabenevolentgovernment,

xSO

R >xSOP .Thereasonforthisovershootingeffectisthat

govern-mentschoosealevelofmonitoringthatminimizestheirﬁnancial

exposureinthefaceofpotentiallyinsolventagents,without

inter-nalizingthecostthattype-Pagentsfaceintermsofhighercare.

Abenevolentgovernment,ontheotherhand,undertakesalevel

ofmonitoringthatinternalizesboththecostsandbeneﬁtsofthe

agents’care.

Thegovernment-paysregimecorrectsthemisalignmentof

gov-ernmentalincentivesbutmayleadtoabiasedgovernmentalaction,

withstrictermonitoringandenforcementagainsttype-Pagents.

Theseresultsareconsistentwiththeanedoctalevidencediscussed

in Section 2,where themediacriticized local governments for

applyingdoublestandardsinenvironmentalprotectiontowards

smalllocalﬁrmsratherthanlargerandwealthierindustries.

4. Comparingregimesinthepresenceofenforcement imperfections

Weextendthemodeldiscussedin Section3toconsiderthe

workingsofthetwo-liabilityregimesinthepresenceof

enforce-mentimperfections,suchasinsolvency,courtdelays,anderrors.

Enforcementimperfections create anundesirable dilution of

deterrenceunderallliabilityregimes.Asit willbediscussedin

thissection,polluter-paysandgovernment-paysregimesrespond

differently to the presence of enforcement imperfections. We

assumethatinagovernment-paysregime,thegovernment

recov-erscompensationpaymentsfromtheresponsiblepartiesthrough

subrogation. Whensuccessfulin a subrogationaction, the

gov-ernment can obtainfull recovery fromtype-R agents, but only

partialrecoveryfromtype-Pagents. Recoverythrough

subroga-tionisnotinstantaneous;trialsarelengthyandrepaymentoccurs

withadelayequaltot.Furthermore,duetothepossibilityofcourt

errors,judicial outcomesare affectedby somedegreeof

uncer-tainty,andgovernmentscanobtainasubrogationjudgmentagainst

theresponsiblepartyonlywithprobabilityps.

Wedenotewithıtheoveralleffectivenessofadjudicationin

asubrogationaction,capturingthecombinedimpactofjudicial

delaysandcourterrors.Theeffectivenessofadjudication,ı,can

bethoughttodecreasefromtheinterestrateranddelaysin

adju-dicationt,andtoincreasefromtheprobabilityofsuccessofthe

governmentinthesubrogationpS.Inanalyticalterms,ı=pS/(1+r)t.

Aperfectlyeffectiveadjudicationoccursonlyinthelimitingcase

withnodelaysinadjudication,t=0(repaymenttothegovernment

iscollectedimmediately),orwheretheresponsiblepartiesgainno

ﬁnancialbeneﬁtfromjudicialdelays,r=0,(zerointerestrate),and

wheretherearenojudicialerrors,pS=1(repaymentoccurswith

certainty).Thedilutioneffectfromineffectiveadjudicationcanbe

reducedoreliminatedbyincreasingthedamageawardinanaction

forsubrogationtooffsetthediscountingfromjudicialdelaysand

legaluncertainty.

In the presence of legal and enforcement imperfections,

the objective function of a representative type-i agent, i=R, P,

becomes31_:

min{x_i}p(xi)ıDi+xi+m(e)(x∗∗−xi) (1)

31_The_dilution_applies_only_to_the_damage_D_and_not_to_the_ﬁne_m(e)._This_implies

thatthepolluter’sinsolvencymayshieldthepolluterfrom(large)environmental

liability,butnotfromthepaymentofaﬁne(i.e.insolvencyisnotassevereasto

makethepolluterunabletopayaﬁne).Likewise,weassumethatgovernmentsare

abletocollectﬁneswithoutdelays.Notehoweverthatourresultsdonotdependon

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Table1

Monitoringandcareinagovernment-paysregime.

Government-paysregime Benevolentgovernment Acomparison

Type-P Type-R Monitoringeffort e∗_R<e∗_P eSO

R <eSOP eSOP <e∗P eSOR >e∗R

Levelofcare x∗

R<x∗P xSOR >xSOP xSOP <x∗P xRSO>x∗R

The objective function of a benevolent government is

unchanged,whiletheobjectivefunctionofagovernmentaffected

byagencyproblembecomes:

min_(e

i)i=R,Pp(xi)i[˛L+ˇ(L−ımin{L,Ai})]+

i=R,P

i(c(ei)+xi) (3)

Legaland enforcement imperfections dilute theagent’s care

incentivesin thesecondstageofthegame.32 _Now_even_type-R

prospectivepollutersmayexertaneffortlevellowerthansocially

optimaldependingontheseverityofthelegalandenforcement

imperfectionsandthesizeofthepenaltym(e).

Proposition5. Thegovernmentexertshighermonitoringon

type-Pagentsthan type-R agents. Thegovernment-pays regimefurther

increasesthelevelofgovernmentalmonitoringontype-Pagents

com-paredtothepolluter-paysregime.

Proof:SeeAppendixA.

Inapolluter-paysregime,thegovernmentalwaysexertsa

posi-tiveeffortontype-Pagents.Monitoringoftype-Ragentsonlytakes

placeifthedilutionofthedirectincentivesissufﬁcientlyhigh.Ina

government-paysregime,thegovernmentexertsapositive

moni-toringeffortonbothtypesofagents,butmonitoringishigherfor

type-Pagents.Thiscanbeexplainedbythefactthattype-Pagents

exposegovernmentstolargerﬁnancialliabilitieswhichheightens

governments’marginal returnonmonitoringefforts.Thisresult

holdseven intheidealworldof perfectadjudication,witht=0

(repaymenttothegovernmentiscollectedimmediately),ps=1(the

repaymenttothegovernmentismadewithcertainty),andr=0

(zerointerestrate).Ahigherlevelofmonitoringfortype-Pagents

alsooccurswhenrepaymentinsubrogationisincreasedbycourts

(asasortofpunitivedamagemultiplier)tooffsettheeffectsof

dis-countratesanduncertainty.Thewedgebetweene∗_Rande∗_Pincreases

asthewealthoftype-Pagents,AP,lowers.

Proposition6. Thegovernment-paysregimeleadstoan

overshoot-ingofcareincentives,suchthatthelevel ofcarechosenby type-P

agentsishigherthanthelevelofcarechosenbytype-Ragentswhen

themonitoringeffectdominatesforthelimitedliabilityeffect.

Proof:SeeAppendixA.

Inagovernment-paysregime,enforcementimperfections

cre-atetwocountervailingeffectsonagents’care.Ontheonehand,

thegovernmentexertshigherlevelsofmonitoringonbothtypes

ofagents,inducingapossibleincreaseintheirlevelofcare.Onthe

otherhand,thereplacementofdirectliabilitywithindirect

liabil-itythroughsubrogationcandilutecareincentives.Theneteffecton

eachtypeofagents’optimallevelofcare,eiistherefore

indetermi-nate.Fortype-Pagents,theimpactofmonitoringismorelikely

todominatethedilution fromimperfectadjudication,sincethe

advantageofimperfectadjudicationissmallerfortype-Pagents,

duetotheirlimitedliability.Thiscanbeseeninthelimitingcase

ofjudgment-proofdefendants(i.e.forvaluesofa→0),forwhich

thegovernment-paysregimeonlycreatespositiveeffectsthrough

monitoring,withnodilutioneffect.Theoppositemaybetruefor

32 _The_proof_follows_trivially_from_Eqs.₍₁₀₎_and₍₁₁₎_in_Appendix_A_and_is_omitted

forbrevityreasons.

type-Ragents,sincegovernmentswilllikelyconcentratemostof

theirmonitoringeffortsontype-Pagents.

5. Thecomparativeadvantageofthegovernment-pays regimeasaninstrumentofenvironmentalprotection

In Section 4 above, we examinedincentives created by the

polluter-paysand thegovernment-pays regimesonprospective

polluters.Inthefollowing,wewillbuildontheseresultsto

exam-inethecomparativeadvantageandthewelfarepropertiesofthe

government-paysregimeasaninstrumentofenvironmental

con-trol. Inarecent paper,Faureand Raja(2010),havearguedthat

oneoftheprimaryreasonsforregulatoryfailurein

environmen-talprotectionindevelopingcountriesisthatpolicymakersdopay

sufﬁcientattentiontothedesignofregulatorysolutionsthatare

appropriatetothelegal,economic,political,andsocialsituations

inwhichtheywillneedtooperate.Inthissectionweconsiderthe

pollutershowthatthegovernment-paysregimethroughthelensof

regulatorydesignsuggestedbyFaureetal.showingthatthis

regu-latorysolutionmaybecomeapreferablemethodofenvironmental

controlin situations characterizedbywidespreadpoverty, high

interestrates,andjudicialdelaysanduncertainty.Our

compara-tiveevaluationofalternativelegalregimesconsidersthewelfare

propertiesandthebiasescreatedbythegovernment-paysregime

relativetothealternativepolluter-paysregime,mappingthe

opti-malscopeofapplicationofeachregime.

Theeffects ofthegovernment-paysregimeontheaggregate

levelofenvironmentalharmcanbeevaluatedbyconsideringthe

expectedharmcausedbytype-Randtype-Pagents.Thetotalsocial

costofenvironmentalaccidentsequalsthesumoftheexpected

environmentallosscausedbytype-Randtype-Pagents,plusthe

precautionandmonitoringcosts,asfoundinEq.(2).Wedenote

withSPP _the_total _social _cost_of _{environmental}_accidents_under

thepolluter-paysregimewhengovernmentandprospective

pol-lutersactoptimally.Similarly,wedenotewithSGP_total_social_cost

ofenvironmentalaccidentsunderthegovernment-paysregime.

AccordingtotheanalysisdiscussedinSection4,theoptimalchoice

ofcareleveloftype-iagent,i=R,Pisafunctionof:

x∗_i =f(ı,,)·i=R,P

whereı∈[0,1]measurestheeffectivenessofadjudication,deﬁned

as ı=pS/(1+r)t, ∈[0,∞] the cost-effectiveness of monitoring

deﬁnedas=ce/pxxe,and=RAP/Lthewealthlevel,givenbythe

percentageoftype-Ragentsin societymultipliedbythewealth

leveloftype-Pagents.

Inordertounderstandtheoptimalscopeofapplicationofthe

government-pays principle forcontrolling environmentalharm,

wedeﬁneaniso-social-costboundarybetweenthetworegimes

asfollows:

SPP₌_SGP ₍₄₎

The iso-social-cost boundary in (4) represents

combina-tions of parameters (ı, , ) for which the polluter-pays and

government-pays regimes prove equally efﬁcient in containing

total environmental loss. Fig. 1 below depicts the

iso-social-cost boundary which helps us compare the polluter-pays and

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Fig.1. Optimalscopeofapplicationofthegovernment-paysregime.

control.Theparametersı,and arerepresentedrespectively

onthevertical,horizontal-left,andhorizontal-rightaxesofFig.1.

Pointsthatfallbelowtheslopediso-social-costfunction

rep-resent combinations of our three parameters for which the

government-pays regime proves more efﬁcient. Points above

the iso-social cost function instead represent combinations of

parameters that render the polluter-pays regime preferable as

aninstrumentofenvironmentalcontrol.Inallpointsbelowthe

iso-socialcostfunction,thebeneﬁtsofshiftingtheincentivesto

governmentoutweightheproblemscreatedbythe

government-paysregime.

Theintuitionbehindthisgraphicalrepresentationexplainsthe

following.Areductionofthewealthlevelofprospectivepolluters,

,hasa positiveeffectonthetotalsocial costofenvironmental

accidentsunderbothliabilityregimes.However,thepolluter-pays

regimeismoresensitivethanthegovernment-paysregimetoa

decreasein(measuredbyandecreaseinRorAPoranincrease

inL).Theslopesalongtheeast-westandnorth-westdimensionsin

Fig.1implythat,forsufﬁcientlylowlevelofwealth(i.e.largevalues

ofpoverty),thegovernment-paysregimemayalsobecome

prefer-ablewhengovernmentismoreeffectiveinmonitoringand/orwhen

adjudicationis imperfect and plagued withjudicial delays and

uncertainty.

Thepolluter-paysregimebecomesamoredesirablealternative

whentheeffectivenessofadjudication,ı,increasesorthe

effective-nessofmonitoring,,decreasesespeciallywhencombinedwith

lowpovertylevels.

Inagovernment-paysregime,forvalues=1thelosstothe

government is associated withthe delays and uncertainties in

thesubrogationaction.Thesecostsincreasewiththetime

neces-sarytorecoverfromtheresponsiblepartiesthroughsubrogation

(i.e.higher t) and withtheinterest rate, r,and decreaseswith

theprobabilityofsuccessinthesubrogationaction,pS.

Govern-mentsmaychoosesomepositivelevelofmonitoringtominimize

thesecosts.Thegovernmentwillexertthesamelevelof

monitor-ingonbothtypesofagents,becauseforvalues=1theagents’

wealthdifferencesdonotaffecttheirabilitytorepayin

subroga-tionandarenotrelevantforthegovernment’schoiceofmonitoring

effort.

Theseresultsshedlightonsomepossiblepolicyissuesforthe

adoptionofthegovernment-pays regime.Aﬁrstpoint concerns

thebestinstitutionalallocationofoversightpowersforthe

moni-toringofprospectivepollutersunderthegovernment-paysregime.

Theprivateandsocialvalueoftherisk-creatingactivitiesis

gener-allyopaquetocourtsandgovernmentalagencies.Forthisreason,

thesevalues do not generallyplay a direct role in tort law. In

theabsenceofawell-functioningliabilitysystem,however,when

careincentivesaredrivenbygovernmentalmonitoring,the

eval-uationoftheprivateandsocialvalueoftherisk-creatingactivity

becomesrelevant.Thegovernment-paysregimedoesnotcreate

immediateincentivesonthegovernmenttotakeintoaccountthe

value of therisk-creating activitywhen choosing a monitoring

level.Aswehaveseen,thismayleadtoamyopicgovernmental

actionthatleadstoanexcessivemonitoringoftype-Pandtype-R

agents.Apossiblewaytoinducemonitoringagenciestoconsider

thevalueoftherisk-creatingactivitieswouldbetofacilitatea

coor-dinatedaction betweenbranchesofgovernmententrusted with

environmentalprotectionandtaxrevenuecollection.Monitoring

thatdistortscareandactivitylevelincentivesreducesthevalueand

thetax-revenuepotentialofthoseactivities—acostthatwouldbe

internalizedandsomewhatcorrectedthroughcoordinated

govern-mentalaction.

6. Conclusions

Inthispaperwehaveevaluatedthedifferencesbetweentwo

typesofenvironmentalregulation: thetraditionalpolluter-pays

principle,wherethepolluterisdirectlyliableforenvironmental

harm,andavariationofthepolluter-paysprinciple,adoptedbya

numberofdevelopingcountries,includingIndia,Malaysia,Taiwan,

Ecuador,Chile,CostaRica,Kenya,andSouthAfrica,amongothers,

wherethegovernmentinsteadisdirectlyresponsibleforpayment

andenvironmentalmonitoring.Wehavecomparedtheincentives

forboththepolluterandthegovernmentunderbothregimes,as

wellasthewelfareoutcomes.

Recentlyenactedlegislationandjudicialprecedentscreatean

obligationonthestatetocompensatethevictimsof

environmen-talharm. Thesereinterpretations of thepolluter-pays principle

holdstateandlocalgovernmentsjointly-and-severallyliablefor

environmentaldamagecausedbyprivateparties,allowingthese

publicbodies to act in subrogation against the individual

pol-luterswhenpossible.Thesesolutionsaimtoensureaneffective

andtimelycompensationofvictims,whichguaranteesreliefeven

whenpolluterscannotbeidentiﬁedorareﬁnanciallyinsolvent.In

addition,wehaveexaminedtheincentivescreatedbythisregime

of governmental liabilityonprospective polluters. We built on

thoseresultstoexaminethecomparativeadvantageandthe

wel-farepropertiesofthepolluter-paysandgovernment-paysregimes

as instruments of environmentalcontrol. We have shown that

government-paysregimesmaybepreferablein situations

char-acterizedbywidespreadpoverty,highinterestrates,andjudicial

delaysanduncertainty.Wefurtherconsideredthewelfare

prop-erties of thegovernment-pays regime, comparingits effects to

those that would be induced by the actions of a benevolent,

welfare-maximizing government. The government-pays regime

mayleadlocalgovernments toactmyopically,choosinga level

ofmonitoringthatminimizestheﬁnancialexposureofthelocal

government but doesnot fully internalize thecosts as wellas

the beneﬁts of the agents’ care. The study of the advantages

andthelimitsofthesealternativeinstrumentsofenvironmental

liabilityprovidesa valuableviewpoint tounderstandthe

inter-action between legal remedies and institutional solutions for

environmentalprotectioninboth developingand industrialized

countries.

Acknowledgements

WewouldliketothankEmanuelaCarbonaraandMichaelFaure

fortheirextensivecommentsandcriticisms,andMaryRumseyand

(9)

AppendixA. Mathematicalappendix

ProofofProposition1. Thetype-RagentchoosesxRtominimize

(1)accordingtothefollowingFOC:

−pxL=1−m(e) ifxR<x∗∗

−pxL=1 ifxR≥x∗∗

(4’)

Itfollowsimmediatelythatx∗_R=x∗∗

Thetype-PagentchoosesxPtominimize(1)accordingtothe

followingFOC:

−pxAP=1−m(e) ifxP<x∗∗

−pxAP=1 ifxP≥x∗∗

(5)

Itfollowsimmediatelythatx∗_P≤x∗∗.

ProofofProposition2. Thegovernmentchooses(eR,eP)to

min-imize(2)accordingtothefollowingFOCs:

dxi

dei(pxL+

1)+ce_i=0 i=R,P (6)

From(6)i=R,eSO

R =0sincepx(xR∗)L+1=0fromProposition1.

From(6)i=P,e_P∗>0sincepx(xP∗)L+1<0fromProposition1.

Taking the ratio of (4) and (5), since pxx>0, it follows that

x∗_P(eSO

P )<x∗R(eSOR )

ProofofProposition3. Thegovernmentchooses(eR,eP)to

min-imize(3)accordingtothefollowingFOCs:

dxR deR[px(x ∗ R)˛L+1]+ceR=0 (7) dxP deP[px(x ∗ P)(˛L+ˇ(L−AP))+1]+ceP=0 (8)

wheredxR/deR=me/pxxL>0anddxP/deP=me/pxxAP>0.

From (7) since eR cannot be negative. From total

differ-ential of (8), e∗_P is increasing in ˇ, where de∗_P/dˇ=−px(L−

AP)/ (pxx+APpxxxRme) (dx/de)−APpxxRmee

Proof of Proposition 4. The benevolent government chooses

accordingtothefollowingFOC:

dxP

deP(px(x

SO

P )L+1)+ce=0

Compare(7)and(8)undertheassumptionthatsecond-order

effect dxP/deP are negligible. Asshown in Proof of Proposition

3,LHSof(8) isincreasingin ˇ.Hence,weneedtoimposethat

L<˛L+ˇ(L−AP).It follows that under thecondition (1−˛) L<

ˇ (L−AP),e∗P>eSOP .

Proof of Corollary. Assume the condition (1−˛)L<ˇ(L−AP)

holds.Takingtheratioof(5)evaluatedateSO

P ande∗P,sincepxx>0,it

followsthatx∗_R(eSO

R )>xR∗(e∗R).Sameproofappliestotype-Pagent.

ProofofProposition5. Thetype-RagentchoosesxRtominimize

(1)accordingtothefollowingFOC:

−pxıL=1−m(e) ifxR<x∗∗

−pxıL=1 ifxR≥x∗∗

(10)

Itfollowsimmediatelythatx∗_R≤x∗∗

Thetype-PagentchoosesxPtominimize(1)accordingtothe

followingFOC:

−pxıAP=1−m(e) ifxP<x∗∗

−pxıAP=1 ifxP≥x∗∗

(11)

Itfollowsimmediatelythatx∗_P≤x∗∗.

Thegovernmentchooses(eR,eP)tominimize(3)accordingto

thefollowingFOCs:

dxR deR

px(x∗R)[˛L+ˇ(1−ı)L]+1

+ce_R=0 (12) dxP deP

px(x∗P)(˛L+ˇ(L−ıAP))+1

+ceP =0 (13)

wheredxR/deR=me/pxxıL>0anddxP/deP=me/pxxıAP>0.

Fromtotaldifferentialof(8),e∗_Pisincreasinginˇand

decreas-ingin˛.Fromthecomparisonof(12)and(13),e∗_P>e∗_R,underthe

assumptionthatsecond-ordereffectdxP/deParenegligible.

ProofofProposition6. Fromthecomparisonof(10)and(11)

undertheassumptionofhighlevelsofmonitoringontype-Pagent

withrespecttotype-Ragent,i.e.e∗_P>e∗_R.

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