The Efficiency Costs of Voluntary Agreements in Environmental Policy

Voluntary agreements (VA) in environmental policy are gaining in popularity. The reason is that governments perceive them as a cost-efficient instrument preferred by industries to fiscal measures such as taxes or auctioned permits. In this paper we dispute the notion that VA programs are cost-efficient policy instruments. In our analytical framework we demonstrate that VA programs can induce significant excess costs due to distortions on the output side of the economy, particularly in industries characterized by increasing returns and oligopolistic competition. We identify important determinants of the magnitude of excess costs and illustrate our findings in the context of simple numerical examples. a University of Stuttgart. b MobiDK Project, Ministry of Business and Industry, Denmark c University of Colorado.