Reverse Grandfathering | Christopher Costello

Christopher Costello, Bren School of Environmental Science and Management will be discussing a paper on Reverse Grandfathering.

Abstract

Markets are increasingly implemented as an alternative to command-and-control regulation, and now exist to manage carbon, air and water pollution, fisheries harvest, water extraction, and a host of ecosystem services. Implementing a new environmental market requires an initial allocation of rights, which can be subsequently traded by regulated firms. In practice, these rights are almost always “grandfathered” to existing firms in proportion to historical emissions or extraction. We ask how grand- fathering impacts incentives, environmental outcomes, and welfare before the market goes into place. We show theoretically that if currently unregulated firms anticipate a future market where rights will be grandfathered, this distorts incentives and induces a race for allocation before the market goes into effect; this can exacerbate externalities such that welfare is lower than under an unregulated equilibrium. We then derive an alternative allocation rule called “Reverse-Grandfathering” that rewards prudence from the past; this significantly improves on unregulated outcomes and under certain conditions can replicate first-best, market-like firm behavior before the market is implemented. We discuss three challenges to this mechanism: incentive compatibility (“participation”), inducing entry, and political economy; these can weaken, but generally do not overturn, Reverse-Grandfathering. We illustrate the role of anticipated allocation rules with a structural model of a hypothetical, but plausible, property rights system regulating fishing on the high seas.

Please email gri.events@lse.ac.uk with the name of the presenter in order to request the Zoom joining details for this workshop by by 5pm on Tuesday 2nd March 2021.