The Costs of Environmental Regulation in a Concentrated Industry

TLDR

Typical cost analyses of environmental regulation rely on engineering estimates of compliance costs, but in industries with significant fixed costs this static approach overlooks dynamic effects on entry, investment, and market power. The study evaluates the welfare costs of the 1990 Clean Air Act Amendments on the U.S. Portland cement industry using a dynamic oligopoly model. The authors employ a dynamic oligopoly framework and the two‑step estimator of Bajari, Benkard, and Levin to recover the industry’s cost structure, including distributions of sunk entry and capacity adjustment costs.

Abstract

The typical cost analysis of an environmental regulation consists of an engineering estimate of the compliance costs. In industries where fixed costs are an important determinant of market structure, this static analysis ignores the dynamic effects of the regulation on entry, investment, and market power. I evaluate the welfare costs of the 1990 Amendments to the Clean Air Act on the U.S. Portland cement industry, accounting for these effects through a dynamic model of oligopoly in the tradition of Ericson and Pakes (1995). Using the two-step estimator of Bajari, Benkard, and Levin (2007), I recover the entire cost structure of the industry, including the distributions of sunk entry costs and capacity adjustment costs. My primary finding is that the Amendments have significantly increased the sunk cost of entry, leading to a loss of between $810M and $3.2B in product market surplus. A static analysis misses the welfare penalty on consumers, and obtains the wrong sign of the welfare effects on incumbent firms.