Can Stricter Environmental Standards Benefit the Industry and Enhance Welfare

This paper argues that the industrialists' claim that stricter environmental standards reduce the industry output, competition, and hence social welfare rests solely on the "cost" effect of a stricter standard and ignores its "demand" effect. It considers situations where firms' pollution abatement increases the industry demand, but, because of inability to coordinate their emissions reductions, and thus free-riding problem, they can not act in their own collective interest. The paper examines the effects of a stricter standard in such situations both at the individual firm and industry levels and when entry/exit is free as well as when the number of firms is fixed. It identifies conditions under which a stricter standard leads to a larger number of firms in the industry, a greater industry output, and a lower total pollution in the long-run; and to higher levels of firms' profits and output in the short-run. It also shows that for the industry to survive, a minimum pollution standard may be necessary. Further, it analyzes the welfare effects of a stricter standard and indicates situations in which the regulator may prefer no standards to weak ones.