Centralized versus local environmental standard setting: firm, capital, and labor mobility in an interjurisdictional model of firm-specific emission permitting

An important public policy question that remains unresolved is whether environmental standards are best set centrally or locally. At the center of the debate is whether devolution can induce jurisdictions of a federation to “race to the bottom” in pursuit of industry and jobs. A widely cited and received exception to this line of reasoning was forwarded by Oates and Schwab in 1988. Their results suggested that immobile homogeneous residents of a jurisdiction trade higher aggregate emissions (localized) for increased wage income in a socially efficient manner. The fixity of the number of firms in each jurisdiction, however, is implicitly assumed and appears to be the linchpin to their equilibrium. This article reexamines potential distortions in decentralized decisionmaking by extending the Oates and Schwab general equilibrium construct to include labor mobility, explicit firm mobility, and firm-specific emission permitting. Whenever firms, labor, and capital are mobile across jurisdictions, decentralized environmental standards can be set too high, too low, or socially efficient depending on jurisdictional production relationships and firms’ responsiveness to key policy variables. This outcome implies that the decentralized efficiency result might not be as prominent as previously argued and appears as a single case in a more general model of decentralized government behavior.