Protecting the Environment: Voluntary Regulations in Environmental Governance

Matthew Potoski, Department of Political Science, Iowa State University

potoski@iastate.edu

Aseem Prakash, Department of Political Science, University of Washington

aseem@u.washington.edu

Introduction

A major trend marks the evolution of environmental policy in the United States and around the world: businesses in growing numbers have been joining voluntary environmental programs (Gibson, 1999; Haufler, 2001). Voluntary programs address the fundamental nature of environmental governance. Many regulators and businesses are looking to use these programs to replace rigid command and control regulatory modes with a more flexible model in which diverse policy approaches are adapted to fit the specific circumstances of regulated firms (Fiorinio, 2000; Kettl and Armacost, 2002). Yet, voluntary environmental programs are controversial (Ayres and Braithwaite, 1992). Many environmentalists charge that some programs are mere "greenwashes" that hide firms’ true pollution records. As a result, they believe in the continuing efficacy of command and control regulation, backed by strong adversarial enforcement (Steinzor, 1998). Needless to say, the recent spate of accounting scandals casts serious doubts about the incentives and abilities of businesses to self-govern themselves. This is important because self-governance in the accounting industry has often been viewed as some sort of a gold standard in terms of industry self-regulation (NAPA, 2001)

Voluntary programs place additional regulatory burdens on participating firms, some that even impose requirements stricter than mandatory law. These programs have been sponsored by governments, industry associations, and non-government organizations. The US Environmental Protection Agency (EPA) and several state agencies have launched over forty voluntary programs, including the 33/50, GreenLights, and Energy Star programs (Crowe, 2000). In the late 1980s, chemical industry associations in several countries independently launched the Responsible Care program (Prakash, 2000a, Garcia-Johnson, 2000), while in 1996 the International Organization for Standardization, a non-governmental entity, introduced the ISO 14000 series.

Against this backdrop, we are studying these voluntary programs (Potoski and Prakash 2002, Prakash and Potoski 2002). In this paper, we first place voluntary programs in the broader scope of environmental governance approaches. We argue that voluntary programs can be usefully viewed as club goods whose important features include the benefits of membership and the boundary conditions distinguishing members from non-members. We then examine the different types of voluntary programs with an eye towards theoretically relevant characteristics that may affect their performance. We conclude with a brief discussion of how voluntary programs may fit in environmental policy scholarship.

Policy Approaches to Environmental Protection

In the US, the environmental governance system has evolved significantly over the years so that it now includes a variety of policy instruments, including command and control, market-based, mandatory information disclosures, and voluntary codes. Command and control policies represent the traditional style of government regulation in which legally binding performance standards such as emissions limits and the use of specific (or best available) technology are prescribed. In the US, command and control regulation took hold at the federal level in the early 1970s with the passage of major environmental legislation such as the Clean Air Act and Clean Water Act. By the 1980s, it became clear that while command and control was initially successful, diminishing returns to this approach were setting in. By rigidly prescribing technologies and leaving firms little operational flexibility, such policies created significant inefficiencies. For regulators, command and control was enforcement-intensive. Declining agency budgets (especially in the U.S.) relative to regulatory mandates seemed to be undermining enforcement frequency and efficacy (Bagby, Murray and Andrews, 1995). To illustrate, between 1996-1998, less than one percent of the 122,226 large regulated facilities nationwide was inspected for all three media (Hale, 1998). And businesses complained that rigid enforcement created high compliance costs that hurt productivity and profits (Jaffe, et al. 1995; Walley and Whitehead, 1994). While command and control regulation may be more effective than no regulation, its high costs suggest there may be more effective and efficient regulatory approaches.

The remaining environmental governance approaches can all be seen as attempts to address the shortcomings of command and control regulations. Market based policy instruments, such as pollution fees, emission taxes, and tradable emissions permits, are touted as efficient policy approaches (Organization for Economic Cooperation and Development, 1989). These policies encourage firms to internalize the costs of environmental externalities through various price signals. While tradable permits for air pollution control have been successful in the US (such as sulfur dioxide emission markets established under the Clean Air Act), they have failed in Poland, Germany, and the United Kingdom (Tietenberg, 2002).

Mandatory information disclosures harness market and nonmarket pressures to influence firm behavior by increasing the amount of environmental information available to shareholders, consumers, and other stakeholders. Information disclosure programs include emissions registers such as the Toxic Release Inventory and product labels. These policies do not specify technologies or emission levels (as in command and control policies), or put a specific cost on every unit of pollution generated by firms (as in market instruments). Rather, they seek to lower transaction costs for various stakeholders about firms’ environmental performance with the hope that these stakeholders would seek to influence it directly (Hamilton, 1995; Arora and Cason, 1996; Khanna and Damon, 1999).

Voluntary environmental codes are designed to encourage firms to voluntarily comply with the mandatory law as well as adopt policies that take them “beyond compliance.” Beginning in late 1980s, interest in voluntary environmental codes has been growing among businesses, trade associations, regulators and even some environmental groups (Gibson, 1999; Haufler, 2001). For businesses, joining an effective voluntary program offers promises on several fronts. First, improving environmental programs and reducing pollution may uncover waste and save costs (Hart, 1995; Porter and van der Linde, 1995). Second, suppliers such as banks and insurance companies may reward firms that join such programs (Schmidheny and Zoraquinn, 1996). Third, consumers may reward firms that subscribe to such policies (Charter and Polonsky, 1999). Fourth, from a strategic perspective, firms may seek to preempt more stringent standards and influence future rulemaking to their advantage (Salop and Scheffman, 1983), thereby reaping first-mover advantages (Nehrt, 1998). Fifth, voluntary regulations may help industry win legitimacy and trust from various stakeholders (Hoffman, 1997).

Voluntary Codes: Key Characteristics

Scholars have only begun to study voluntary programs. One way to help advance this study is by identifying different types of voluntary programs based on potentially relevant theoretical criteria. To do so, we begin by exploring the institutional characteristics of voluntary programs. A major focus of the public policy/ political economy literature is to understand under what conditions institutions -- rules that prescribe, permit, or prohibit certain actions (Ostrom, 1986) -- arise and how institutions facilitate collective action. Because voluntary codes represent collective action, it is imperative to understand their institutional characteristics.

The public policy literature classifies goods and services according to their excludability and rivalry/subtractability (Ostrom & Ostrom, 1977). The objective of this classification is to identify the conditions under which markets and other institutions function efficiently in terms of facilitating collective action. Markets function well if those paying for products (the provisioners) have the right to appropriate the products' benefits and to exclude others who are not paying for them. Otherwise, the non-provisioners will 'free ride,' thereby discouraging the provisioners from paying as well (Olson, 1965). Thus, the fear that others may free-ride becomes a key reason for the failure of collective action.

Based on the twin attributes of excludability and rivalry, products can be classified in four stylized categories: private goods (rival, excludable); public goods (non-rival, non-excludable); common-pool resources (rival, non-excludable); and impure public goods (non-rival, excludable) (Ostrom & Ostrom, 1977). Traditionally, governmental provision of collective goods -- public goods, impure public goods, and common-pool resources -- has been viewed as necessary because their provision is susceptible to market failures (Pigou, [1920]1960). However, a number of scholars have shown that other institutional vehicles can correct market failures as well (Coase, 1960; Ostrom, 1990). Specifically, non-governmental actors can successfully provide impure public goods (Tiebout, 1956; Cornes & Sandler, 1996). As suggested by Prakash (2000), there are two types of such impure public goods: toll and club. Toll goods such as movie theaters can be unitized so that consumers reveal their preferences by paying for the additional units they consume. This transaction is carried out by levying a user toll. In contrast to toll goods, the discrete consumption units of club goods cannot be priced since it is difficult to estimate their marginal costs. Membership fees (reflecting average costs) are used instead to finance their collective provision.

Voluntary codes can be conceptualized as club goods whose benefits are excludable but non-rival. By establishing boundary conditions, voluntary goods create an institutional distincentive against free riding, thereby encouraging collective action. Thus, from a firm's perspective, the attractiveness of a voluntary code hinges both on the quantum of net benefits it provides to the firm and on the level of excludability of such net benefits that it offers to club members. Defining and enforcing boundary conditions (more below) at low transaction costs become important elements in influencing the adoption rates of voluntary codes (Prakash, 2000b).

Below we present key characteristics of voluntary programs, along with how they might influence firms’ adoption rates and their environmental and regulatory performance. Along the way, we point to some examples of interesting programs along these dimensions.

Program Requirements: A key element of any voluntary program is what is required of participants – the costs of retaining membership to the club. Programs may require participants to:

• adopt an environmental management system;
• adopt specific pollution prevention techniques;
• self-police their environmental performance, report non-compliance to regulators, and promptly correct the problem;
• hire third-party auditors to check compliance with program’s requirements;
• share data with external stakeholders on environmental performance and regulatory compliance;
• involve external stakeholders in environmental management decisions;
• demonstrate "beyond compliance" with environmental regulations.

More onerous requirements may deter firms from participating, but they are obviously important for the credibility of the program. The costs of these requirements are an important factor in firms’ decisions about whether they will join the program. Depending on the firm and the program requirements, some firms may easily meet program requirements without taking on any additional burdens; joining a voluntary program can help these firms publicize their environmental progressivism. Program requirements can also serve as benchmarks for environmentally laggard firms.

Eligibility: Eligibility refers to which firms can potentially join the program. Such boundary conditions are defining features of any club. Political boundaries are an obvious eligibility criteria for most government-sponsored programs. For example, the European Union’s Eco-Management and Audit System program is limited to firms located in the European Union (Kollman and Prakash, 2001). Eligibility can also be restricted by other criteria, such as industry or sector; Responsible Care membership is limited to firms in the chemical industry. Another important eligibility requirement is limiting participation based on firms’ environmental track records. Nineteen state environmental leadership programs require eligible firms to have strong environmental track records in order for them to participate (Crow 2000). Setting stringent eligibility standards may be a double-edged sword. While narrowly targeted programs with stringent criteria can be more credible and therefore more attractive to firms, such criteria can lead to low participation rates and therefore undermine the program’s effectiveness. Thus, the program sponsors have to decide on the appropriate trade-off between eligibility stringency and participation rates.

Sponsorship: Voluntary programs have been sponsored by governments (such as the 33/50 and Performance Track programs), non-government organizations (such as ISO 14000 and CERES Principles), as well as industry associations (such as the American Chemical Council’s Responsible Care). Sponsors, in this sense, are the organizations that make rules and enforce them. The issue of sponsorship is important for the legitimacy of the programs, which in turn influences firms’ incentives to join them. Typically, environmental groups have been skeptical of programs sponsored by industry associations, and perhaps to a lesser extent, by non-governmental bodies that have industry participation (ISO 14001 being a notable example). The sources of this skepticism vary: environmental groups are often excluded in program formulation; program requirements are not stringent; enforcement/monitoring is poor; and sanctioning for non-compliance is trivial. Government-sponsored voluntary programs may potentially have more credibility with environmental groups, primarily because they may not have the problems identified with industry-sponsored programs.

Incentives for Joining: As mentioned earlier, firms can reap many non-monetary and monetary benefits for joining voluntary programs. One critical issue is whether these benefits accrue predominantly to club members or spill over substantially to non-members. As suggested earlier, to minimize free riding, non-members should be excluded from the benefits of club membership. Spillovers to non-members create incentives for free riding and hence undermine the benefits of club membership. Below we list several excludable benefits for joining environmental programs. Fortunately, sponsors of voluntary programs can devise appropriate rules to reduce spillovers. Some excludable program benefits include:

o Regulatory benefits, including streamlined permit review, fewer inspections, and even forgiveness for violations voluntarily disclosed in good faith;

o Technical assistance, including pollution prevention audits, compliance audits, and information sharing with other participating firms;

o Financial benefits, including lower pollution fees and tax credits;

o Public recognition, including allowing firms to advertise membership in the program.

Successful voluntary programs such as ISO 14001 have thousands of participants worldwide, despite certification costs as high as $30,000-$100,000 per facility. Participation in such programs varies dramatically across industries, countries and programs, suggesting that firms are still wary of taking on the program costs.

In the US, states have been experimenting with voluntary program incentives. For example, several states have adopted environmental audit laws that grant privilege and/or immunity for self-disclosed regulatory violations. The problem with such laws, as environmental groups have pointed out, is that firms may opportunistically exploit the laws by simply preemptively self-reporting their pollution violations. Voluntary programs may provide an antidote to such problems by allowing governments to selectively reward firms that participate in good faith. Finally, it is worth noting that publicity can serve as a powerful incentive for participation. Publicity may work better in markets where consumers reward firms for environmentally progressive policies; information about a business’ environmental performance doesn’t do much good for the business or consumers if consumers do not use the information in purchasing decisions. If environmental protection is a "post-materialist" value, this means the economically advanced countries, particularly with active environmentalists in their citizenry, such as Germany and the Scandinavian countries.

Sanctions: Covenants without swords are mere words. Thus, it is important to understand how sponsors monitor compliance and sanction non-compliance. Sanctioning options are somewhat limited for voluntary programs. Firms would be understandably reluctant to expose themselves to punishment beyond what the law requires. Nonetheless, effective voluntary programs probably need some mechanism for identifying and removing laggard firms. While such enforcement may be less of a problem for government-run programs, it can clearly be quite challenging for NGO-sponsored programs, such as ISO 14001.

Conclusion

If voluntary programs are to be credible for regulators and environmental groups as legitimate modes of environmental governance, they must be credible on three fronts. First, government regulators must believe that participating firms are behaving in good faith. That is, regulators must believe that firms reporting compliance are, in fact, in compliance and firms that report violations have taken reasonable steps to comply with regulations. Second, firms must believe that governments will deliver on promised incentives and sanctions. To some extent, the goodwill benefits of environmental programs among consumers and other stakeholders may compel some firms to join voluntarily programs without government-sponsored incentives. But such incentives will help governments only to the extent that the consumers and other stakeholders hold firms accountable for things the governments also want. Third, environmental groups must believe that voluntary agreements and the related programs truly help improve environmental protection. Many environmental groups are quick to assume, and not without reason, that too much cozy cooperation between government regulators and firms is a recipe for sacrificing environmental protection for good feelings and easy publicity.

As with any public policy, the ultimate test of voluntary programs is whether they deliver on promised objectives. Scholars have only begun to investigate these issues (Sholz, 1991; Harrison, 1996; Gibson, 1999; Haufler, 2000; Garcia-Johnson, 2000), and while some results so far are promising, important questions remain about these programs. Two central questions stand out. The first centers on who joins voluntary programs. Are participating firms those with strong environmental records? Does varying incentives affect participation rates? The second, and perhaps more important question, centers on whether joining environmental programs improves firms’ environmental performance. Of course, this is not a simple question: the efficacy of these programs is likely to vary not only across programs, but also across different institutional, policy and economic circumstances.

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