Inefficient Local Regulation of Local Externalities

Abstract

The consequences of commitment failure have been missing from debates about the decentralized regulation of automobile emissions and other sources of local consumption externalities. Even when the direct effects of such products are limited to a single jurisdiction, the presence of increasing returns-to-scale production causes one jurisdiction's choice of regulatory standard to affect the prices and availability of goods elsewhere. The commitment failure generates divergent standards that split production and deny consumers the full range of products. The result is inefficient in that it is dominated by standards that allow all production to be consumed everywhere. Coordination failures may cause similar inefficiencies. The results question the usefulness of the principle of subsidiarity as commonly employed.

Keywords: local externality, federalism, subsidiarity, environmental regulation

JEL Classification: D62, H73, K32