POLLUTION ABATEMENT AND UNEMPLOYMENT. A
METHODOLOGICAL STUDY
John Hoicka, et al
Institute of Public Administration
Washington, D. C.
31 January 1972
NATIONAL TECHNICAL INFORMATION SERVICE
Distributed ... 'to foster, serve
and promote the nation's
economic development
and technological
advancement.'
U.S. DEPARTMENT OF COMMERCE
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Pollution Abatement
and Unemployment
A Methodological Study
Institute of Public Administration
l6t9MASSACHUSeTTSAVE N.W WASHINGTON DC 20036
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POLLUTION ABATEMENT AND UNEMPLOYMENT
A Methodological Study
I .
This report was prepared by
John Roicks, Principal Investigator,
Terry Trumbull and Helen Scott
January 31, 1972
Submitted to the
Office of Air Programs
and the
Office of Wa ter Programs
of the
Environmental Protection Agency
under Contract # EHS 70-126
Submitted by the
Institute of Public Administration
1619 Massachusetts Avenue, N. W.
Washington, D. C. 20036
(202) 667-6551
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11~~STXTUTE OF PUBLIC ADMINISTRATION
11119 MASSACHUSETTS IIV'i:NUE, N. W. 0 W...SKINGTON, D. C. . 202-11117-1111111 CABL.E: "INSTADMIN"
". ; t~. ~'Ift"" ."'.'QI!tNT'
SUMNER MYERS, DIRECTOR
URBAN SYSTEMS STUDIES
January 31, 1972
Office of Air Programs
Office of Water Programs
Environmental Protection Agency
5600 Fishers Lane
Rockvi11e, Maryland 20850
Gentlemen:
I am pleased to transmit the attached report, Pollution
Abatement and UnemploYMent: A Methodolo~ical Study, by the
Institute of Public Administration. The report was undertaken
for the Office of Air Programs and the Office of Water Programs
of the Environmental Protection Agency under Contract EHS-70-126.
The study develops a methodology to esttmate the magnitude of
unemployment that may be expected as a result of plant closures
caused by pollution abatement requirements. Three case studies
are provided as practical illustrations of the methodology and a
chapter on Federal programs completes the report.
Preparation of the report was the responsibility of
John Roicka, Principal Investig~tor, Terry Trumbull and ~e1en
Scott. Research assistance wasprcovided by Ralph Loewenstein and
Arthur Wineburg.
We would like to express ou~ appreciation to those staff
members of the Office of Air Programs and Office of Water Programs
who commented on the draft version of this volume in December 1971. .
Their suggestions have been incorporated in the appropriate sections.
Sumner Myers
Project Director
SM:dff
TRUSTEES:
LUTHER GULICK. CHAIRMAN
RICHARD S. CHILDS. VICE CHAIRMAN
JOHN S. LINEN. TREASURER
FRANCIS W. H. ADAMS
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TABLE OF CONTENTS
SUMMARY
CHAPTER 1 -- METHODOLOGY (PART I):
AN OUTLINE
Summary of Estimation Procedures for Non-Viable Plants
Low Pollution Abatement Costs
Price Increases
Plant Closures
Short-Run Plants
Differential Pollution Abatement Costs
CHAPTER 2 -- METHODOLOGY (PART II):
PRICE INCREASES
Industries with Concentrated Control
Regulated Industries
Impersonal Markets
Price Inelastic Demand
Price Elastic Demand
Labor Intensive Industries
Capital Intensive Industries
Resource Intensive Industries
Close Substitutes
Differing Pollution Abatement Regulations
CHAPTER 3 -- METHODOLOGY (PART III):
PLANT CLOSURES
Short-Run Plants
Capital Intensive Industries
Labor Intensive Industries
Differential Pollution Abatement Costs
Plant Size
Plant Age
Pap;e
1
1-1
1-2
1-3
1-4
1-7
1-7
1-8
2-1
2-1
2-2
2-3
2-4
2-5
2-7
2-10
2-11
2-11
2-13
3-1
3-1
3-1
3-5
3-5
3-8
3-12
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-~'-'.'-4--""'"
11
Pa~e
ClfAP.TER 4 -- THE PROBLEM OF FINANCING AND' EVALUATIVE
CRITERIA
4-1
Summary
4-1
Evaluative Criteria
Payback Ability
Liquidi ty
Borrowing Costs
Uncertainty
Misinformation
Irrational Prejudice
Short-Term Effect
4-2'
4-4
4-4
4-9
4-9
4-10
4-10
4-11
CHAPTER 5 -- CASE S'nJDIES
5-1
CASE STUDY #1: GRAY IRON FOUNDRIES.
Objective
Context
Industry Economics
Pollution Abatement Costs
GIF -1
GIF-l
GlF-l
GlF-l
GIF-2
Economic Analysis
1.0 Price Changes
2.0 Differential Cost
2.1 Cost Differentials for Foundries
2.1.1 Long-Run
2.1.2 Short-Run
3.0 Sensitivity Analysis
3.1 Stability of Price Considerations
3.2 Differential Pollution Abatement Costs
3.3 The Effect of Misinformation.
3.4 Uncertainty
3.5 Sunmary
GlF-4 I
GlF-4
GlF-5
GlF-6
GlF-7
GIF-8
GlF-10
GlF-10
GlF-12
GlF-14
GlF-15
GIF-15
CASE S'nJDY 112: PORTLAND CEMENT INDUSTRY
Objective.
Context
Industry Economics
Pollution Abatement Costs
Cement-l
Cement-l
Cement-l
Cement-l
Cement-3
Economic Analysis
1.0 Incidence of Average Pollution Abatement
Co s ts
1.1 Long-Run Incidence
1.2 Short-Run Incidence
Cement-5
Cement-5
Cement-6
Cement-6
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Hi
2.0 Differential Cost
2.1 Causes of Differential Cost.
2.2 Cost Differentials for Cement Plants
2.2.1 Long-Run
2.2.2 Short,:",Run
2.3 Summary
3.0 Sensitivity Analysis
3.1 Stability of Price Considerations
3.2 Differential Pollution Abatement Costs
3.3 The Effect of Misinformation
3.4 Uncertainty
3.5 Summary
CASE StUDY 113: PRIMARY COPPER SMELTERS
Objective
Context
Industry Economics
Pollution Abatement Costs
Economic Analysis
1.0 Price Changes
1.1 Long-Run Incidence
1.2 Short-Run Incidence
2.0 Differential Cost
2.1 Causes of Differential Cost
2.2 Cost Differentials for Smelters
2.2.1 Long-Run Plants
2.2.2 Short-Run Plants
3.0 Sensitivity Analysis
3.1 Average Pollution Abatement Costs
3.2 Differential Pollution Abatement Costs
3.3 The Effect of Misinformation
3.4 Uncertainty
3.5 Summary
CHAPTER 6 - - PROORAMS: LEGAL REQUIREMENTS AND POLICY
ALTERNATIVES
Summary
Government Regulation -- Legal Implications
Program Alternatives
Selectivity
. Pa~e
Cement-8
Cement-8
Cement-9
Cement-IO
Cement-ll
Cement-14
Cement-14
Cement-14
Cement-IS
Cement-16
Cement-17
Cement-17
Copper-l
Copper-l
Copper-l
Copper-l
Copper-3
Copper-5
Copper-5
Copper-6
Copper-7
Copper-8
Copper-8
Copper-9
Copper-IO
Copper-ll
Copper-12
Copper-12
Copper-13
Copper-14
Copper-14
Copper-IS
6-1
6-1
6-3
6-7
6-8
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:Lv
~~-ViabIe Plants
f,J(5) Assistance
Frictional Problem AssistancOe
Sub~idies
Variances
Strategies for Potentially Viable Plants
Government Loans
Variances
APPENDIX A -- ECONCMICS (F THE INDIVIDUAL PLANT
The Decision to Abate
Differential Pollution Abatement Costs
Future Closures
Plant Reductions in Employment
APPENDIX B -- LEGISLATIVE CONTROL OF POLWTION ABATEMENT
Effects of Differing Standards
Water Pollution
Air Pollution
Movements Toward Uniformity of Standards
International Control Requirements
SELECTED BIBLIOGRAPHY
GLOSSARY
ItmEX OF SYMBOLS
Page
6-9
6-9
6-10
6-10
6-12
6-13
6-13
6-16
A-I
A-I
A-2
A-4
A-S
B-1
B-1
B-2
B-3
B-3
B-4
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INDEX OF TABLES
Page
Table 1-1 ANNUALIZED INVES'lMENT COST OF AIR POLLU -
TION ABATEMENT AS A PERCENTAGE OF VALUE
OF SHIPMENTS 1-5
Table 2-1 PAYROLL AS PERCENTAGE OF VALUE ADDED IN
TWENTY INDUSTRY GROUPS - 1967 2-8
table 2-2 MAtERIALS AS A PERCENTAGE OF VALUE OF
SHIPMENTS lWENTY-ONE INDUSTRY GROOPS-1967 2-12
Table 4-1 INDEX OF RELATIVE TRADE CREDIT STANDING OF
BUSINESS BY SIZE AND AGE 4-6
Table 4-2 DISTRIBUTION OF TOTAL BANK CCI>1MERCIAL
LOAN MONEY -- 1957 4-8
Table 4-3 PROPORTION OF BANK CCHmRCIAL LOAN MONEY
GOING TO SMALL AND LARGE FIRMS ACCCIU>ING
TO TERMS OF THE LOANS -- 1957 4-8
Table GIF-l SHORT-RUN VIABILITY GIF-ll
Table Cement-l SHORT-RUN VIABILITY Cement-13
b '
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SUMMARY
1.
1~ recent years, the Federal Government has set air and water
pollution standards which will requite plants to invest in pollu-
tton abatement.
In most industries virt~ally all plants will be
able to pass on the costs of pollution abatement in the form of in-
creased prices.
Consequently, this study is directed at the very
small minority of plants that might reduce or cease operations and
thereby layoff their employees.
This report specifies the types of financial assistanc~ required
to avoid closure, provides a methodology to estimate the order of
magnitude of unemployment, and describes the kinds of plants affected
and programs which might be instituted, should the need arise.
2.
Plants may reduce or cease operations in order to avoid the ex-
pense of pollution abatement for one of two mutually exclusive reasons
and, on this basis, are here divided into two groups:
a) non-viable plants, i.e., those which cannot. afford to
pay for pollution abatement costs and would therefore
require a subsidy if they are to continue in operation,
and
b) potentially viable plants,i.e., those which could pay
pollution abatement. costs !! they could secure a loan
to cover the necessary i~itial outlay but are. unable
to borrow the necessary funds from a commercial lending
institution.
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It is significant that those plants which ~ abate will neither re-
duce nor cease operations prematurely as a result of abatement, and
hence are not subjects for concern from a policy viewpoint.
3.
Non-viable plants will generally be found among the smallest
and/or the most obsolescent in each industry.
The number will be
reduced if the standards applied to these plants are less stringent
than the standards applied to large plants.
4.
Commercial lending institutions may refuse loans to some potentially
viable plants because they underestimate the plant's ability to pass
on the cos~s of pollution abatement in the form of increased prices.
5.
A preliminary survey indicated that data needed to support a refined
model were unavailable, and further, that data such as financial projections
for individual plants would be very costly to obtain.
A methodology was
therefore developed which could use the available data.
While the resultant
model is crude, it can be used to estimate the order of magnitude of unem-
ployment that may occur with the two categories of plant, discussed above: the
economically non-viable, and the potentially viable.
Only published data need
be used throughout with the exception of estimates for pollution abate-
ment costs for small or obsolescent plants.
The latter,can be easily
developed by EPA if it wishes to use the model.
Three case studies,
for illustrative purposes only, apply the methodology to three dif-
feren~f types of industry:
labor, capital, and resource intensitive.
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6.
As the case studies illustrate, the methodology may provide estimates
of plant closures and unemployment that are relatively precise for some in-
dustries whUe being less so for others.
These discrepancies can be expec-
ted to offset one another in summing the estimates for all industries.
From
a policy point of view, the important ~est1on is whether the sum of all the
estimates provides a measure of unemployment at the national level that is
sufficiently reliable to form th~ basis for a decision.
7.
The methodology identifies certain industries where pollution abatement
is most likely to result in unemployment.
If these industries are considered
critical in some sense, EPA may wish to conduct more intensive studies of
the impact of abatement requirements on the small and/or obsolescent
plants in the industries so identified.
8.
Again, this is a methodological study, and quantitative results
are for illustrative purposes only..
In the course of the analysis,
however, three findings of particular significance emerged.
a)
Many plants which close rather than abate would have
closed in any event within a period of a few years.
b)
Because a large proportion of these plants are small
or obsolescent and are located in economically stagnant
or declining areas, a disproportionate share of closures
will be in areas of chronically high. unemployment.
Pollution abatement will compound the problems already
,
responsible for the declining fortunes of" these plants.
The extent of the ensuing unemployment will depend on
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- 4 -
such factors as the nature and severity of the legis la-
tion imposed, the location of the plants, and the age
distribution and skills of the employees.
. c)
The number of potentially viable plants~that is, plants
needing loans-is likely to be very small.
9.
The study also provided insights into the appropriate types of
Federal Government response, should the magnitude of unemployment
warrant action.
a)
There is no point in considering loans for non-viable
plants, because the plants will be unable to repay the
loans.
For non-viable plants, the options are as follows:
i)
No assistance.
This decision would force plants to
close and employees to seek unemployment benefits through
Social Security and other programs.
In such instances,
retraining and relocation assistance might be provided
to displaced workers.
In either case, the costs will
ultimately be borne by consumers and the displaced workers.
ii)
Subsidies.
Abatement costs could be directly sub-
sidized wholly or in part.
In most instances a combina-
tion of subsidy and loan assistance would be sufficient,
the amount of the loan being dependent upon the plant's
ability to repay it.
i1i)
Variances.
Variances are a form of indirect sub-
sidy.
If a variance i8 granted, damages caused by pollu-
tion will still persist, but in areas where there are
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'"-_.-..__._-_._~~---- ._--_.~.._.---
. 5 -
f~ pollutets the effects may be small and ambient air
or water qUilitty- standards may not be v1.olated.
b)
WhUe. small plants, hav1ng less to offer as security,
do exper!.ence greater cUfficulty than large plants in
borrowing money frdm c08ercial sources, there is no
evidence to sugges't that they are victims of unfair dis-
cr:tm1nation.
The Small Business Administration is designed
to assist firms' that are Unable. to comply with established
lending practices, and whose loan applications have been
rej ected &y banks.
There appears to be no reason why
the SBA should not resolve problems concerned with loans
to cover air pollution costs.
c)
A generally successful company may own one or more plants
that are economically non-viable and each of these plants
may thus qualify for a subsidy. It should be noted,
however, that no subsidiary of a successful parent company
could be regarded as "potentially viable" since it must
be assumed that a loan could be arranged through the
parent.
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CHAPTER
1
METHODOLOGY (PART I): AN OUTLINE
In order to know anything it is necessary to know
everything, but in order to talk aboui anything it
is necessary to neglect a great deal.
In order to estimate the potential number of non-viable plants
in U.S. industry and the associated magnitude of unemployment, three
points
to be noted are:
1.
Plants (or operations within plants) will close down
rather than abate if the investment cost of pollution abatement (i.e.,
exclusive of operating and maintenance costs) exceeds the anticipated net
present value of the plant;
2.
Future unemployment is not a policy issue because once abatement
is carried out, the life expectancy of the remaining plants will, in most
cases, increase.
Similarly, after an initial delay, employment in the re-
maining plants will probably increase slightly.
3.
Plant ownership is not an issue since economically non-viable
plants will close whether or not they are part of a prosperous multi-plant
2
concern, and the resulting unemployment will be the same.
1. Joan Robinson, "Rising Supply Price," Economica N.S., Vol. VIII
(1941), p. 8.
2. These points are discussed in mathematical terms in Appendix A,
Economics of the Individual Plant.
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1-2
S~ary of Estimation Proceaur~s for Non-Viable Plants
Pf the hundreds of thousands OfP~8 oper4ting in the United
~''::.~es"onl;ya few will close down (or abandon operations) rather than
comply with pollution abatement requi~~nt8.
Even if the data were
:~:l1ai1able, it would be extremely costly to cull the closures from the
£:cst through a plant by plant analysis.
In point of fact,.. fi1?-a~ci~l ..
~~ojections are closely guarded secrets and it is difficult to acquire
;,'"Uution abatement cost data that is more refined than the industry
.1.evel.
While there are some differences in the procedures followed by
's~gle-plant and multi-plant concerns" 1:hey are not easily identified
J~ quantified owing to the secrecy surrounding financial data.
Generally
:.~:.eaking, multi-plant concerns have more options, in that they can rearrange
~>'roduction among different plants, move equipment, transfer skil~ed labor,
('7tds,o forth.
But since the question addressed in this report concerns
2~~ployment, no attempt is made to differentiate unemployment caused by
'c';";J;.lt1-plant concerns 'from that caused by 8i11:gle plant entities.
The estimation procedure suggested here seeks to provide a cost-
3tfective estimate of the nationw~de ~pact of closures on unemployment.
Ji.r!.~.ed on readily available da,ta, it provides ,only a crude approximation
- 1
to ~he actual number of closures in each industry. Accuracy for a specific
~. In the summer of 1970, President Nixon invited Dr. Paul McCracken to
h:ad an inter-agency Task ,~orce tostudytb,e .~conomic im~act of pollution
c~;~lU.:ol and to recommend, if necessary, measures to ease the burden. A
~~nge of costs for the control of pollution under existing standards has
been pI:epared for, eleven iuc\us,tries ,~onsid,ered to be major polluters and
the impact on E!II\ployrqent ,al\d profit;ability isuow being studied by private
consulting firms. The industries ar.e: a~~omobiles, ,bakeries, cement plants,
~ron fqundries, canned and frozen fruits and vegetables, pr~ry non-ferrous
~,.8e:(:Lll:" pulp and paper, petroleum refining, leather, steel and electric
'1£ ti LI. ties.
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1-3
industry, however, is important only insofar as it affects the aggregate
figures of closures and unemployment. .
By summing low and high estimates of closures in each industry,
a range is obtained for the economy as a whole.
A disproportionate
share of the unemploYmen~as estimated, will be long-term in nature, be-
cause a disproportionate share of plant closures will be in the regions of
chronic unemployment.
Only if the range, as revised to consider long-term
unemployment, is not sufficiently accurate to determine an appropriate
federal response, need refinements be made.
In this latter case, detailed
studies might be carried out for those particular industries whose est~ates
significantly affect the total dispersion in the estimates.o~ n~tj.op.~.l
unemployment.
Low Pollution Abatement Costs
For many industries, the initial outlay, [i.e., the investment
cost of pollution abatement (PA)J, is so small that a negligible number of
plants would be forced to close purely as a result of the financial burden in-
volved.
For estimation purposes, then, the first step is to exclude
from consideration industries for which this cost is very low.
The overall cost of pollution abatement to the plant is
based on the costs incurred by the firm or plant itself and changes in
the cost of materials purchased which have resulted from pollution
abatement in the supplying industries.
Unfortunately, analyzing this
stream of costs might involve a complex, possibly computerized, model
which might well be beyond the scope of the effort suggested here.
One fairly reasonable substitute would be to compare the cost of
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- .__.~.- ---~-_.----- - ---~_...._'._-,--. ---'-"---'--.'---"-"--'
1-4
;po.l1ut:Lon abatement within a given industry to value added.
Alternative-
1y, ~e cost could be compared to value of shipments, although in most
ca$es this would understate the price increases required to break even.
The appropriate definition ofPA should include the capital,
C9st of pollution abatement in excess of an established norm for the in-
d\1stry.
Recently, more stringent legislation has been enacted for several
types of abatement.
The incremental cost to each plant is, of course, the
sum of incremental costs of each type of abatement.
Information available 4uring the course of this study related
only to the incremental costs of air pollution, though EPA is now in
the process of estu.ating s~ilar data for other kinds of pollution
abatement.
For lack of this other data the figures for air pollution
were used in the case studies, then, on the understanding that quantita-
tive results were for illustrative purpos~s only.
In Table 1-1, EPA estimates of the investment costs of air
pollution (column 3) are compared with annual value of shipments for
1
the industry as a whole (column 1). The ratio exceeds l'percent in
c~~,1.y ten cases, and 5 percent in only one case.
It appears, there-
iore, that plant closures due to pollution abatement will be lUnited
to a very few industries.
P.;:1ce Increases
Since an entire industry must abate, the add~d cost is
1. In most cases the inQustries defined are not
specific 4-digit Standard Industrial Co~e (SIC),
have been unable to compare the inve~tment C081;:.S
ment with value added.
equivalent to a
and therefore we
of pollution abate-
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Table 1-1
ANNUALIZED INVESTMENT COST OF AIR POLWTION AY TEHENT AS
A PERCENTAGE OF VAIm: -mr-SHIPMEm'S'}- -
(Fiscal.Year 1976; 298 Metropolitan Areas)
Value of Annualized2 Annualized Investment Cost
Shipments Inves tment Investment as a Percent of Value of
($ billions) ($ millions) ($ mUlions) Sh ipmen ts
Asphalt Batching 1.6 15.4 .. 3.1 0.2
Brick and Tile 0.2 40.8 8.2 4.1
Coal Cleaning 0.8 13.1 2.6 0.3
Cemen t 0.9 110.0 22.0 2.5
Elemental Phosphorus 0.13 6.6 1.3 1.3 3
Grain: Handling N/A 436.0 87.2 If/A
Milling 4.8 27.4 5.5 0.1 J
Gray Iron Foundries 3.5 317.3 63.5 1.8
Iron and Steel 17.4 981. 0 196.2 1.1 t->
Kraft (sulfate) Pulp 3.7 73.0 14.6 0.4 I
VI
Lime 0.3 10.6 2.1 0.7
Phosphate Fertilizer 1.8 32.1 6.4 0.4
Primary Nonferrous
Metallurgy: Aluminum 1.1 223. 3 44.7 4.1
Copper 0.8 87.0 17.4 2.2
Lead 0.1 16.2 3.2 3.2
Zinc 0..3 4.7 .9 3.0
Rubber (Tires) 4.6 1.9 .4 0.9
Secondary Nonferrous Metallurgy 1.8 61.9 12.4 0.7
Sulfuric Acid 0.3 176.0 35.2 11.8
Varnish 0.1 .8 .2 0.5
1.
Estimated costs for controlling particulate, sulfur oxide, carbon monoxide, bydrocarbon,
and lead emissions from facilities expected to be operating in fiscal year 1976. Credit
creased sulfuric acid is not included. The metropolitan areas are defined, Economics of
Append ix 1.
Capital related share of annual costs or approxUnate1y 1/5 of the investment cost.
Not applicable
fh10ride
for 1n-
Clean Air,
2. .
3.
Source:
Adapted from the Economics of Clean Air, Report of the Administrator of EPA to tbe U. S.
Congress (Washington: GPO, 1971) pp. 4-19, 4-20.
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.,'t~-....
1...6
~tmilar in nature to other casts imposed by tegulation.
Just as an
e,~c:tse tax, for example, is promptly.pa:Ued on in the fom of increased
1
prices, so will pollution abatement ~Osts be passed on in many instances.
It ~il1 be difficult to raise prices if the produ~t has close sub-
st1tutes, or if the industry has substahtial international (or inter-
~egional) competitors with much lower abatement costs.
But apart from
these situations, the procedure for estUDating price increases may ~
summarized as follows:
(1)
For many industries in the United States, ownership or
control is concentrated in the hands of a relatively small number of
firms.
In these cases, it is relatively ea8y t. increase prices to
~over the pollution abatement costa of most, if hot all of the plants
in the industry.
(2) In industries with aiffused ownership, price changes are
dictated by the elasticities of demand and supply.
The fo l10wing
8eneralizations~may be made:
(a)
If demand is price inelastic, most plants will be
able to cover their cos~s of pollution abatement, at
least approx~tely, by raising their prices as the
costs are incurred.
(b)
If demand is price elastic, on the other hand, the
\)
response may vary according to the type of industry.
The ~ore labor intensive the industry, ~he more quickly
10 If the industry is resource intensive, some of the costs may be
shifted back onto the resource owners. In any event, the process it-
self is either capital or labor intensive, and the general conclusions
hold. '
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1-7
will prices be increased, even if production must be
reduced as a result. If the industry 1s capital in-
tensive
and excess capacity exists, the price increase
may be delayed until demand has grown to meet supply.
At that time, the price will increase rapidly to the
point at which most plants recover their costs.
It follows, therefore, that prices increase rapidly except
when a concentrated capital intensive industry faces elastic demand
and excess capacity at the same time.
Plant Closures
There are two principal reasons why plants close instead
of abating.
If there are indications that a plant is liable to close
within a few years in any event, the necessity of making an initial
outlay for pollution abatement might decide management that it would
be wiser to cease operations bmnediately.
Such plants may be t enned
"short-run."
Or, alternatively, plants might have costs of abatement
so much above the industry average (i.e., differential costs) that
the unrecovered costs would exceed the discounted cash flow for the
plant.
These two issues are examined in the sections below.
Short-Run Plants.
The investment cost of pollution abatement
is assumed to be borne over a period of ten or more years at an interest
rate of 14 percent.
Plants that will probably not survive so long must
amortize the cost over a shorter period of time.
In other words,
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1-8
't:.t\e net: pr~8ent value of the plant might be 80 small that it is exceeded
JY the in~s~ent cost of pollution ab~tement, and the plant will then
cease operations.
An average lifespan required to j:uatt1£y eontinued operations
C411 Be estimated, albeit in a crude manner.
On one side of the ledger
:.eJ the investment cost of pollution abatement.
On the other side
is the sum, for a given number of years, of the estimated net present
i,.-:Jlue.
To estimate the latter figure accurately wou1d require financial
projections for individual plants, and these, as has been noted, can
only be obtained at great expense.
The procedure used here is to
~tilize industry average figures for small plants in labor intensive
industries, and to modify these figures by an estimate of relative
~ayroll costs for obsolescent plants in capital intensive industries.
The rtumber of plants which would close within the compared time period
is estimated by projecting the failure rate of the industry.
This
figure has been multiplied by an estimate of plant employment to arrive.
ut potential unemployment.
Differential Pollution Abatement Costs.
Costs of Poll~tion abate-
.~e~t; particularily initial capital expenditure, frequently vary as a
~rdportion of sales for differential plants in a given industry,even if
,;irnilar equipment is required of a11.
The t~o major determinants of such
'tifferences are plant size and plant age.
-------
1-9
~o far as size is concerned, economies of scale for pollution abate-
ment equipment essentially favor the larger plants.
This advantage is
more significant for labor intensive than capital intensive industries,
since there is considerable size variation in the former as against a
tendency to uniformity of size in the latter.
Investment in pollution
abatement equipment will change the relative labor/capital intensity of
an industry;
a probable response, from labor intensive industries in par-
ticular, will be mergers between smaller plants or their absorption by
larger competitors.
Differences in plant age create an abatement cost differential
Which generally operates in favor of newer plants.
Installation of equip-
ment in older plants is often hampered by the/fact that their original de-
sign may not have taken pollution abatement requirements into account.
Existing systems, for similar reasons, may need extensive and expensive
alteration.
In addition, plants employing obsolescent processes may have
difficulty in absorbing high pollution costs, since there is so little
return for them over and above payroll and the cost of supplies.
Factors affecting the methodology applied to non-viable plants,
as
outlined above, will be developed in more detail in the two following
chapters.
1. The considerable variation in legislative requirements for pollution
control 1s another important factor 1n cost differentiation. See Appendix B.
-------
CHAPTER 2
METHODOLOGY (PART II):
P~ICE INCREASES
The general conclusion of this chapter is that.in the large
majority of industries virtually all plants will be able to increase
their prices by an amount that is adequate to cover the .costs of pollu-
tion abatement.
Notable exceptions to this generalization are dis-
cussed below (see p. 2-11).
Industries with Concentrated Control
It is quite common for U.S. industries to be dominated by a few
large companies.
One highly regarded study notes, for example, that
in 1954 four (or fewer) firms controlled the following percentages of
value of shipments: primary aluminum (100 percent), passenger auto-
. I
mobiles (98 percent) electric lamps (93 percent), and so on.
In such industries, one can hardly say that "impersonal market
forces" determine the level of prices.
Rather, prices are decided
according to accepted conventions, varying by industry.
In some cases,
there is strong price leadership, and a single firm dictates a set of
prices maximizing its own return, subject only to extreme discontent
by weaker firms.
In other cases, ~~ one firm does predominate,
different firms may tentatively raise or lower prices to test the
reaction of the industry.
Frequently ,the result is an intricate bid-
ding process, in which other firms respond with different changes,
and gradually a new price level is es~ablished.
1. Joe S. Bain, International Differences in Industrial Structure
(New Haven:. Yale University Press, 1966), p. 78. .
-------
2-2
In this type of situation, if a new cost such as pollution abate-
ment is Unposed, it provides a ready i~itial signal about the probable
size of the next price increase.
The precise amount of the increase
will depend upon the exact nature of the bidding process, the number
of other issues involved (such as wage increases) and the recent his-
tory of price increases in the industry.
Not infrequently, costs such as pollution abatement or wage
increases provide an excuse to raise prices to a level that includes
a profit increase as well.
Such pretexts are considered necessary
because U.S. industry is usually reluctant to maximize short-run pro-
fits if it might hinder long-run existence and growth.
Noticeably high
profits might lead to investigations by the anti-trust division, con-
sumer advocates, or political interests.
In addition, a rapid increase
in profits generates a demand by labor for increased wages.
It follows
then, that price increases in industries with concentrated ownership
will adequately cover the costs of most, i£ not all, plants in the
industry; indeed many will probably increase profits as well.
Re~lated Industries
One of the primary purposes for regulating an'industry is to
control monopolistic tendencies.
Within the established framework
of controls, it is a comparatively simple matter for the regulatory
agencies to permit price increases to cover the costs of pollution
abatement.
-------
. ..~.
-----
2-3
ifu~ersonai Markets
Price changes in an impersonal market can be estimated by making
Use of economic analysis of sui>piy and demand.
In classical economic
theory, the price of a prodtict d$peftds on supply and demand, assuming
that both producers and buyers have complete freedom of choice, as
well as the ability, to produce and buy according to their own best
interests.
. .
When the supply and demand curves intersect, a market
equilibrium of quantity and price is created.
While shift in supply
and demand may upset the equilibrium in the short-term, the same shifts
will, in the long run, result in a new equilibrium.
!n the present analysis, pollution abatement results in a
shift of the supply curve:
supply diminishes at each potential price.
Figure 1 illustrates the situation.
Curve DD represents demand for
the product; it slopes downward to reflect the fact that the quantity
demanded increases as price decreases.
The initial supply curve, SS,
on the other hand, slopes upward, since the quantity supplied and
price are positively related.
In both instances, the sharper the
slope, the less sensitive is demand or supply to the price changes.
FIGtmE
1
Price
D
/Sl
/'
s
1 '
p
p
q,
q
Quantity
-------
2-4
A second supply curve, S'S', is drawn above the first,
<...
indicating the effect of the increased costs of pollution abatement.
Figure 1 shows that the price of the product will increase from p to pI,
and the quantity decreases from q to qt.
It is evident that the magni-
tude of each of these chan~es depends upon the magnitude of pollution
abatement costs and the slopes (or in~~ast~citie~) of the two curves.
A number of points should be made.
First, if the new
equilibrium reduces trade, a number of plants within the industry
1
will reduce or cease operations before this equilibrium is reached.
,
i
I'
Second, the supply curve may not be shifted to its full extent
immediately.
The course it follows depends upon characteristics
of the industry.
Third, during the time taken for adjustment, increas-
ing national or regional income may cause the demand to increase at
each potential price, thus shifting the demand curve outward.
This
increase in demand may suffice to lessen, or even eliminate, the
reduction in quantity.
Price Inelastic Demand
If demand is price inelastic, prices will increase rapidly to
cover the costs of pollution abatement for most, if not all, plants
in the industry.
Unfortunately, estimation of price elasticity is ex-
tremely difficult and requires sophisticated statistical methods.
Reasonably accurate results are available for a few commodities only.2
1. Establishments will not reduce operations proportionately if pollu-
tion costs are not the same in relation to value of shipments. (See
Chapter 3.)
2. See Herman Wold and Lars Jureen, Demand Analysis (New York: John
Wiley and Sons, 1953).
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2-5
The approach sel~~~~here is to utilize a few simple guidelines
tha1!,~ .can be used to indicate roughly ~he price elasticity of demand.
1
fol~awing canclusians are disc~~sed in many microecanomic textbaoks.
The
1.
If clase substitut,es~re.ava:Llable, (and their price in-
creases are smaller) t demand is likely ta be somewhat price
elastic.
2.
If the praduct is usually bought far use in combination
with other goods (e.g., gasoline), demand is likely to be some-
2
what price inelastic.
3.
If the price of the product is a small proportian of the
consumer's budget (e.g., table salt), demand is, again, likely
to be somewhat price inelastic.
Acting on these broad assumptions, it can nevertheless be a complex
matter to decide whether a particular product is price elastic or in-
elastic.
Usually a number ,Of considerations peculiar to that product
have to be weighed
judiciously before arriving at a definite conc1u-
sion.
Price Elastic Demand
If demand is price elastic,on the other hand, it is difficult
to incre~se prices without repercussions in the industry.
Whether
the price increase is delayed~ or production is reduced depends on the
1. See John R. Hicks, Value and capital (2d ed.: Oxford: Clarendon
Press, 1948), p. 32-36; a~d J~es M. Henderson and Richard E. Quandt,
fticroeconomic Theory (New YQrk:McGraw Hill, 1958), p. 26. Other
elements influencing demand include quality, service, etc."
2. See Close Substitutes and Differin~ Pollution Abatement Re~lations,
below.
-------
2-6
price elasticity of supply for the industry.
The supply curve for the produc~ depends upon the supply curves
for the various factors of production:
labor, capital, and resources
or ,supplies.
An industry may have constant costs because its derived
demand for factors is so small in relation to quantities traded in
the factor market tbat changes in the industry's demand do not affect
factor prices.
This situation occurs when factors are sufficiently
mobile to shift from the industry in question to other industries
(at least in the long run).
In this case long-run supply of the prod-
uct is extremely price elastic, and the price will be increased by
the full amount of the pollution abatement cost.
The number of plants
and the output of each will then depend on the exact price elasticity
of demand and the rate at which demand increases over time.
An industry may be subject to increasing costs if it purchases
a significant proportion of specialized factors that have few alterna-
tive uses.
To the extent that this is so, the price increase will not
reflect pollution abatement costs to the full because part will be
borne by the suppliers of the specialized factors through a reduction
of their prices.
The division of burden between resource owners and
consumers again depends upon the price elasticity of demand, as well
as the rate at which
demand increases over time.
Even when supply contracts have been made on a long-term basis,
it may be possible to renegotiate the price if this is necessary to
save the producer from bankruptcy.
This is most likely to happen
if the market for raw materials is controlled by a few firms.
-------
2c7
'.
1f demand is pri~~ ~lastic, it follows that price ~lasticity
of supply is Unportant in determiniD$ th~ rate and magnitude of price
changes associated with air p~llutto~ control.
It may therefore be
helpful to discuss this poin~ in rel~~ion to the three types of in-
dustry under consideration in this study.
Labor Intensive Industries.
A labor intensive industryl is
defined as an industry that uses a relatively large proportion of
labor in relation to capital.
Table 2-1 indicates in a rough manner
the relative labor intensity of various two digit Standard Industrial
Code (SIC) industries surveyed in the Census of Manufacturing in
1967.
Taking 47.1 as the average percentage for all manufacturing,
it follows that as an industry payroll exceeds this percentage of
value added it is more readily defined as labor intensive.
Labor -- especially unskilled labor -- is relatively mobile.
It is no particular advantage for an unskilled worker to remain with
the same firm, so that if there is any question of a pay-cut he will
2
probably change his job rather than accept lower wages. A skilled
worker has a stronger motive to remain with the same firm.
His
training has meant an investment in time (both for himself and his
I
I
1. "Case Study Ill: Gray Iron Foundries" (Chapter 5) has been pre-
pared as an example of the effect of pollution abatement costs on a
labor intensive industry, albeit of one with price inelastic demand.
2. One source points out that most employees will have very little
information about their alternative prospects and hence will feel that
they should search for a new, and posstbly better-paying" job before
accepting the reduction in pay. As the search continues unsuccess-
fully, expectations tend to be revised downward. Axel Leijonhufvud,
On Keynesian Economics and the Economics of Keynes (New York: Oxford
University Press, 1968), p. 77 ff.
-------
2-8
Table 2-1
PAYROLL AS PERCENTAGE OF VALUE ADDED
IN 'lVENTY INDUSTRY GROUPS - 1967
Industry
Rank
Payroll as percfnt
of Value Added
Total Manufacturing
Lumber & wood products
Leather & leather products
Apparel & other textile products
Furniture & fixtures
Transportation equipment
Textile mill products
Electrical equipment & supplies
Fabricated metal products
Machinery, except electrical
Printing & publishing
Miscellaneous manufacturing industry
Primary metals industry
Rubber & plastics, n.e.c.
Stone, clay & glass products
Paper & allied products
Instruments & related products
Food & kindred products
Chemicals & allied products
Petroleum & coal products
Tobacco manufacturers
47.1%
56.2%
55.5%
55.4%
54.1%
53.8%
53.8%
52.9%
51.6%
51.1%
49.8%
49.8%
49.3%
48.3%
45.9%
45.4%
43.9%
37.8%
27.4%
22.4%
18.4%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Source: U.S. Departmentof"Commerce, Bureau of the Census, 1967 U.S.
Census of Manufacturing: Industry Statistics, Vol. II (Washington, D.C.:
Government Printing Office, 1970).
-------
2-9
~ployer) and money, it\. that he has accepted lower initial wages during
1
tlH.s period.
Alternative jobs are fewer in number for him than for
the unskilled worker and he is therefore more likely to accept a tem-
2
porary pay cut.
His interest in remaining in his job decreases in
direct ratio to the expected duration of the pay cut.
Companies are
often unwilling to risk losing skilled employees by imposing temporary
pay cuts.
lt follows, therefor~, that as the industry becomes more labor
intensive the distinction between the short-run and long-run supply
curve becomes less clearly defined.
Thus prices will increase rapid-
ly, even if this means a reduction in output associated with price
elastic demand..
Even so, the reduction in output will be small if substitute
products also increase in price owing to the costs of pollution abate-
men t .
Another possibility is that the industry can utilize suppliers
1. Gary S. Becker, Human Capital (New York:
Economic Research, 1964).
National Bureau of
2. This setting helps to explain why management is often able to
perform sudden cost-cutting exercises in a recession. Business Week,
for example, noted:
When top management realized last summer [1970] it was
contending with a recession, the knee-jerk reaction was
to launch far-reaching cost-cutting campaigns. Unemploy-
ment rolls swelled, and in .some cases employees took pay
cuts ...
This article continued, however, that as business conditions improved,
wages were restored for those who ,had taken cuts) AIldmanagement was
starting to refill positions left vacant by economy moves. Many of
the moves were essentially short-run cuts designed to for~e workers
who depended on the company's success to share part of the costs of
uncertainty. "Trimmed Paychecks Put Back Lost Weight," Business Week
(July 17, 1971), p. 35.
-------
2-10
as "insurance" against short-run fluctuations in demand and.profit-
ability. 1
Capital Intensive Industries.
An approxtmate indication of capital
intensity is given by a firm's ranking as indicated in Table 2-1.
Firms
. . 2
with a low payroll as a proportion of value added are capital 1ntens1ve.
The distinguishing feature of a capital intensive industry is that
large sums of capital are committed to an establishment, and then have
relatively little use in alternative situations.
This Unmobility is
likely to be reflected in a reluctance to invest capital until a return
seems assured, but once the investment is made,m~nagement finds that
it is usually best to operate either close to full capacity or not at
all. Supply is therefore price inelastic in the short-run but price
elastic in the long-run.
If demand is price elastic, increased costs caused by new
pollution abatement requirements may not be passed ~ediately if
demand is weak or excess capacity exists.
Prices will rise gradually
as demand for the product increases because construction of new
capacity will be delayed until profits return to normal. (i.e., long-
run supply is inelastic).
1. The automobile industry provides an appropriate example. When
the industry anticipates suddenly reduced profits, for example, during
the recent (1971) wage price freeze, buyers for the various companies
attempt to renegotiate with suppliers to obtain lower prices. These
tactics could not succeed if suppliers did not regard their overall
arrangements with the companies as satisfactory.
2. "Case Study i12: Portland Cement Industry,"(Chapter 5) has been
prepared as a simple example of the effect of pollution abatement
costs on a relatively capital intensive industry, albeit of one with
price inelastic demand.
-------
, "
"-_.._-
2..i1
Resource Intensive,Industries. Th~ distinguishing feature
. 1.. 1
A resource intensive industry is that it depends to a great extent
of
on raw materials.
As Table 2~2 iridicates, cost of materials averages
just over half the value of tnduatrlal shipments.
Often industries
processing raw materials, such as copper or petroleum, have a cost
of materials much greater than the industry average.
When this happens,
the shape of the supply curve becomes fmportant because it affects
analysis of the response to pollution abatement costs.
If demand is price elastic, it may be difficult to increase prices
rapidly.
Since the process itself is either capital or labor intensive,
the industry reaction can be determined by reference to the sections
above.
If reductions in output do occur, the industry's derived demand
for raw materials may fall perceptibly.
As a consequence, prices for
the raw material will weaken, both in the short- and long-run, with
the result that consumers and resource owners will share the burden
of pollution abatement costs.
As a secondary consequence, there will be a dfminution in the
size of the resource intensive industry caused by reduction in demand,
'r
and possibly a loss of markets to foreign competition.
Close Substitutes
Some products have close substitutes and therefore price in-
creases are made with difficulty.
In the production of soap, for
1. "Cas~ Study 113: Primary Copper Smelters"
prepared as a simple example of th~ effect of
costs on a resource int~nsive industty.
(Chapter 5) has been
pollution abatement
-------
2-12
Table 2-2
MATERIALS AS A PERCENTAGE OF VALUE OF. SHIPMENTS
'l'WEN'l'Y-ONE INDUSTRY GROUPS-1967
Industry
Materials as percent of
value of shipments
Rank
All Indus try
53.6%
Petroleum and Coal Products
Food and Kindred Products
Textile Mill Products
Transportation Equipment
Tobacco Manufactures
Primary Metal Industry
Lumber and Wood Products
Paper and Allied Products
Apparel and Other Textile Products
Leather and Leather Products
Fabricated Metal Products
Rubber and Plastic Products
Furniture and Fixtures
Miscellaneous Manufacturing Industries
Electrical Equipment and Supplies
Chemicals and Allied Products
Machinery except Electrical
Stone, Clay and Glass Products
Ordnance and Accessories
Instruments and Related Products
Printing and Publishing
76.(170
68.5%
59.3%
59.0%
58. 6%
58.3%
55.6%
53.8%
53.1%
49.2%
48.3%
46.8%
46.7%
45.4%
44.8%
44.6%
43.8%
42.5%
40.6%
36.3%
34.6%
I
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
Source: U.S. Deparbnent of Commerce, Bureau of the Census, 1967 U.S.
Census of Manufacturin~: Industrv Statistics. Vol. II (Washington, D.C.:
Government Printing Office, 1970).
-------
2-13
exa.mple, many diffet'ent kinds o£ oUs can be used.
If the price of
o~ is increased noticeably, it may ~imply be replaced by another.
Since the processes used to make palm oil, 80Y bean oil, and other
kinds of oil differ markedly, i~ is quite possible that the costs
of abatement will also differ markedly, and an industry may have to
absorb a substantial portion of the costs or lose much of its market.
It appears, however, from the list of industries considered by the
CEQ to be major polluters that this is not a very important issue.
1
DifferinR Pollution. Abatement ReRulations
In most instances, the effect of differing interregional
or international pollution abatement regulations will be to keep the
industry price increases to a minimum.
While it is true that foreign
industry, assuming it has lower pollution abatement costs, will
expand and take over some of the U.S. demand, this is more a long-
run than a short-run problem.
In any case, if the effects of foreign
competition become appreciable, new technology will be devised to
reduce the costs of pollution abatement.
To the extent that this
technology is successful, American industry will be able to regain
part of the market lost to foreign firms.
In fact, it is easy for
several reasons to over~tate the effects of abatement costs in terms
of international trad~.
Al~ major U.S. trading pa+tn~rs are becoming aware of the
importance of pollution control and any price advantages their goods
1.
See Also Appendix B.
-------
2-14
1
may have in this respect will be temporary.
In Canada and Scandinavia,
for example, strict pollution control laws have already been enacted.
Furthermore, many of the new requirements for pollution abatement with-
in the United States require the use of specialized capital equipment
for goods that are only sold in the domestic market.
Thus, foreign
producers are faced for these goods with a non-trade barrier because
their own domestic markets for these goods are so small that it is
2
uneconomic for them to compete in the American market.
Finally, most American goods differ to some extent from the
goods of other countries, either in terms of product differentiation
or transportation costs, and this fact tends to limit the encroach-
ment of foreign producers.
1. Since the trade advantages will come only to those industries
with extraordinary pollution problems, Americans will, in effect,
be exporting pollution to other countries. If a rapid buildup of
heavily polluting industry occurs abroad, public pressure will mount
very quickly to have the pollution controlled, even though foreign
populations are at present unconcerned. It is frequently the case
that major changes contain in themselves the seeds of reversal of
that change.
2. The requirements for low pollution automobiles in 1975 is a well
known example which appears to be very disadvantegeous to foreign
car manufacturers.
-------
CHAPTER 3
METHODOLOGY (PART III):
PLANT CLOSURES
There are two principal reasons why non-viable plants close
instead of abating.
First, i£ there are indications that a plant is
liable to close within a few years in any event, the necessity of
making an initial outlay for pollution abatement might decide manage-
ment that it would be wiser to cease operations immediately.
Second,
plants might have costs o£ abatement so much above the industry average
that the unrecovered costs would exceed the discounted cash flow for the
plant.
These tMO issues are examined in the section below.
Short-Run Plants
Plants which must bear the costs of pollution abatement over
a very short period of time are particularly likely to cease opera-
tions.
The different characteristics relating to each type of in-
dustry iri this connection are discussed below.
Capital Intensive Industries
As a plant become obsolescent, it will tend to lower prices
rather than layoff workers.
Thus, instead of decreasing production
over the years, the plant will exhibit declining return to invested
capital.
Finally, of course, it will produce only during peak periods
of demand.
Another manifestation of the same result -- lack of com-
petitiveness -- is apparent if the firm has high variable costs
relative to the industry average, i.e., labor and supplies, compared
to value added.
-------
3-2
This lack of competitiveness is reinforced by the nature of
decisions made in a capital intensive industry.
So long as a new cost
is minimal, it does not precipitate consideration of the plant's
ceasing operations.
But, more importantly, capital expenditures are
viable only if the ~lant is likely to operate for a considerable
number of years with a good profit.
Therefore, when doubt exists in
the minds of managers as to the viability of the plant, major expendi-
tures are often delayed in favor of increased maintenance.
As more
decisions are made in favor of variable cost solutions, the variable
cost of the plant tends to climb.
This reluctance to purchase new
equipment soon reaches a point of no return, and the overall level
of variable costs becomes far greater than the industry average.
I .
Particularly in the case of price elastic demand, obsolescent
establishments may have difficulty in ablorbing the short run costs.
In some cases, this cost will be so high that the establishment will
cease operating, possibly blaming pollution regulations.
The principal reason why these plants close, however, is that
they are no longer competitive and would have closed in the near
future in any case.
Often, the defining characteristic of this type
of plant is that the cost of supplies and wages of production workers
combined are a far higher proportion of the cost of production than
the industry average.
Another reason is that the value of capital
invested in the plant has already sunk to a minimum thus reflecting
all of the factors, including technological obsolescense, which indi-
cate the plant is in its last years.
Usually, there will be other
telltale signs.
In the plant itself, capital equipment has been
-------
.-.i.. .
3~3
allo~edto run down over a number of years and employment, oth~r
than for maintenance, has decr'eas.ed.
The industry has probably
experienced a series of closures among old plants over a period of
several years.
In other words, pollution abatement require~ents can
be considered only as the straw that broke the camel's back; and straw,
even a minor technological advance in the industry, might be 8u££i-
cient to close these plants.
FIGURE
1
CASH FLOW
OUT-OF-POCKET COSTS
REVENUES,
o
Tl
TIME
As Figure 1 illustrates, revenues exceed out-of-pocket costs
until time tl; the time at which the plartt would close in the abaence
of pollution abatement requirements.
The shaded area, when discounted
appropriately, represents the net present value of the plant.l
Once abatement is required, both curves shift upward, though
not necessarily by the same amounts.
ttowever, the plant will con-
tinue to operate only if the revised net present value of the plant
exceeds the initial outlay, or investment cost, of pollution abatement.
1.
An adjustment must be made for salvage value.
See Appendix A.
-------
3-4
An estimating procedure was developed as follows.
First,
out-of-pocket expenses were assumed to be a specific proportion of
revenues; i.e., the ratio of payroll to value added for the group
'-
of obsolescent plants under consideration.
To the payroll was
added an estimate of the return to capital expected if the plant
were scrapped.l
For the model plant, an arbitrary life span is
assumed.
The failure rate for industry, when projected, indicates
FIGURE
2
CASH FLOW
REVENUES
PAYROLL AND RETURN ON SALVAGE VALUE
PAYROLL
o
T
1
TIME
;
how many plants will close each year.
Consequently, the arbitrary life
span for the model plant is increased until net present value exceeds
the initial outlay, or investment cost of pollution abatement, an
estimate of the number of closures is obtained.
This figure is
multiplied by employment per plant to esttmate the resulting un-
employment.
Because the rectangle of Figure 2 is only a gross approximation
to the shape in Figure 1, a sensitivity analysis is carried out by
varying the magnitude of pol~ution abatement costs. (i.e~, by applying
1. An over estimate is use~ here to reduce the size of the estimated
discounted cash flow (Figure 2) and therefore overestimate the like-
lihood of plant closures.
-------
3~5
14rger or smaller cost esti~tes t~ ~etermine whether conclusions are
~~~n!f~~antly affected ~y sq~h variation),
If the resulting varia-
tion in probable number of closuret!J"(and ~~eociated unemployment)
\$ lJ~gt:J.ificant, and provi4ed that f~l.p"'res for the economy as a whole
.re excessively 'broad for po~~~~ ~~~o~@e, t~en EPA might commission
a specific study which would esti~te unemployment more precisely.
Labor Intensive Industries
Since plants in labor intensive industries have (by definition)
very little capital invested, it is not easy for them to compete with
a more efficient plant by ~ccepting ~ lower return to capital.
It
is much more likely that such a plant will curtail its market, giving
up its distant customers to a more efficient competitor, and dropping
its least profitable products.
Plants in labor intensive industries,
then, signal their likelihood of closure by reducing output and employ-
ment by substantial amounts over a period of years, reflecting the
gradual erosion of their protected market.
This means that the ratio of payroll to value added is much
less variable for plants in a labor than in a capital intensive in-
dustry.
Consequently, the industry average is used for estimation
purposes.
Otherwise, the ~st~mat~~n procedure used is the same as
for a plant in a capital intensive industry.
Differential Pollution Abatement Costs
.., ~ ~., .:. ~.. '-'.'.-'....
Two reasons for di£ferenti~l costs of pollution abatement are
discussed here:
economies of scale for pollution abatement, equip-
ment, and the possible high cost of ~ba~~ent for obsolescent plants.
-------
3-6
Appendix B considers a third reason for differential costs:
varying
legislative requirements by state and country.
It is assumed that different "plants within an industry will
be required to make roughly proportionate reductions in pollution.
This assumption will not be universally valid; abatement legislation
may be sufficiently flexible to ease requirements for small plants.
If so, differential costs as computed in this study may be reduced,
even to insignificance.
It should be noted as well that differential costs of pollu-
I .
I
tion abatement relate primarily to different relative initial capital
outlays.
TWo reasons are here advanced for this stress.
First, most operating and maintenance costs tend to be pro-
portional to the ~ of abatement equipment, and therefore, to a more
limited extent, to plant output.
One example of costs that vary in
direct proportion to production is the substitution of fuels that
cost more for fuels that pollute more.
Fuel combustion tends to bear
a direct relationship to output.
Some of the pollutants -- for example,
particulate matter and sulfur oxides -- can be reduced by changing
to fuels (such as natural gas) which emit less of the pollutant.
The cost per unit of production, then, will be insensitive to both
size and age of establishment.
Similarly, unless the technical pro-
cesses differ. substantially, other operating and maintenance costs
-------
+---_.
,"
-------. --. .--.---.-.
.. ~--------- - ..
3...7
. '
'-1i11 not differ sign'ificantly in relation to output among plants'
~ithln an industry. 1
Second, as outlined in Chapter 1, The Problem Defined, it is
the' ihitial decision to abate OT' to cease operations that i8 of
interest.
'!be plants which do abate,' will', if anything, tend to
employ more workers and to produce for a longer period of time than
if the industry had not faced ~ requirement to abate.
The cost of capital equipm~nt for pollution abatement, on the
other hand, does not tend to in~rease proportionately with output.
The costs are incurred initially as fixed costs, and little can be
recouped if production diminishes or ceases.
In industries where a large pbrtion of total annual costs con-
sists of the annualized costs of the initial capital outlay, dif-
ferential of pollution abatement costs may well be substantial.
For
e*ample, air pollution control increases the cost of castings made
in large gray iron foU~dries by only 0.7 percent, while the increase
1s 3 percent for castings made in single cupola foundries.2
There
are two basic reasons for differential costs of pollution abatement
equipment:
different plant size and different ages.
1. Production of lime, for example, results in considerable emissions
of particulate matter, 'especially from the newer rotary kilns. One
with a daily capacity of 400 tons, re~uires a venturi scrubber with
investment cost of $30,000 (i.e., $6,000 per year) but operating and
maintenance cos ts of $39,000 per year. Consequently, the di,fferen-
tial impact of air pollution abatement within the industry will be
minor. See Report of the Administrator of the Environmental Protec-
tion Agency, The E~ohomics of Clean Air '(Washington, D., C.: 'GPO,
March, 1971), p. 4-87.
2. Economic ImPact ,ofAirPo11ud:bn Controls, U. S., Department of
Health, Education and Welfare (Washington, D. C.: GPO, August, 1970).
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3-8
It has been assumed that all plants within an industry are
required to install appropriate equipment to abate.
This may not
always be true where water pollution is concerned.
Small plants are
frequently allowed to hook up to municipal sewage treatment plants.
Their investment costs are, therefore, converted into operating
costs; hence, in conjunction with economies of large scale associated
with municipal plants, differential costs may be eliminated.
Plant Size
Small plants tend to have relatively high costs of pollution
control when expenditure on equipment is a major portion of the bill.
Building a small piece of equipment usually requires as much skill,
expertise and labor as a larger unit.
Thus, while costs for large
and small plants may be fairly close, the available capacity and hence
the quantity of goods produced by each are very different.
Con-
sequently, the larger establishment obtains equipment at a much
lower cost per unit output than the smaller.
Since labor intensive industries tend to serve local markets,
plants vary in size according to their location.
By contrast, when
an industry requires significant capital outlays, plants are fairly
uniform in size because the concomitant economies of scale tend to
override the advantages of conforming to requirements of specific
markets.
,
If a labor intensive industry is required to make a significant
investment in pollution abatement equipment, the new entity (i.e.,
-------
-.-.-,-.-.-,..-----~.- --_.~-,-----,-,_.. -.----..,- -- .""--,_.
,3-9
arter pollution abatement) is more capital intensive than before.l
Tfl!~ fueans that as a new equilibriUm for the industry develops,
plint~ will tend to become more unitotm in size.
In essence, econo-
mt~s of scale for pollution abatement e~uipment favor the larger
j;lants.
Local market orientation may be the result of either product
differentiation or high shipping costs.
In the former case, there
are advantages in locating different plants near one another, called
economies of agglomeration.
For example, a pool of trained workers
can be built up in a given area, and potential buyers can visit
several plants before making up their minds.
If one plants closes, its business (and employees) will quickly
be ab.orbed by its competitors.
If the management of a plant feels
that pollution abatement costs will force it out of business, a
merger can often be effected with another firm in similar circumstances,
9'0 that the costs of pollution abatement to the combined concern will
be reduced.
High shipping costs in an industry lead to differences in
plant size because regional markets vary considerably in their total
1. The assumption here is that all 'plants will have to use, essentially
the same kind of equipment (i.e., abat'e by approximately the same
percentage). If less is required of 'small plants, differential costs
will be less important.
-------
3-10
demand. 1
Typical examples of industries with high shipping costs
are gray iron foundries, brick and tile, and bottling plants.
Large
producers are often located in or near large cities, with smaller
plants supplying the smaller communities, and each faces competition
from only a limited number of sources.
It is interesting to note that in many of these industries,
recent changes in transportation have already disrupted existing
markets, forcing some plants to close.
In particular, the Federal
Interstate Highway system has considerably reduced the cost of
trucking. 2
As a result of improved highways, some large plants have
been able to expand their operations and encroach on the protected
(i.e., isolated) markets previously served by small local plants.
1. A number of economists have linked shipping, or transportation,
costs to the number and size of establishments in a given industry.
One of the best treatments is given, for retailing, in W. Arthur
Lewis, "Competition in Retail Trade," Overhead Costs (London: George
Allen & Unwin, Ltd., 1949), pp. 116-156. Other include Harold
Hotelling, "Stability in Competition," Economic Journal, Vol. 39
(March, 1929), pp. 41-57; A. P. Lerner and H. W. Singer, "Some Notes
on Duopoly and Spatial Competition," Journal of Political Economy,
Vol. 45 (1937), pp. 145-186; Walter Isard, Location and Space Economy
(New York: MIT Press, 1956), pp. 77 ff; and William S. Vickrey,
Microstatics (New York: Harcourt, Brace & World, Inc., 1964),
pp. 323 ff.
2. "Since construction began, fifteen years ago, the Interstate has
changed life and work, for better or worse, over much of the nation."
"If anyone had realized the sheer magnitude of the interests affected
by this road system," says Moynihan. . ., "it is impossible to imagine
that it would ever have been built." "The engineers who designed the
system in the late 1930's were certainly oblivious of the social and
economic implications of what they were proposing, as were Congress
and President Eisenhower, who put the plan into motion ~n the 1950's."
Juan Cameron, "How the Interstate Changed the Face of the Nation,"
Fortune (July 1971), p. 80.
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3-Jl
,.
This market expansionl has often enabled larger plants to
undercut the prices of the~r smaller rivals and some of the smaller
plants have had to close down or ~erge in order to compete.
'!bus
(although differences in size ~y stiil by substantial), the number
of plants has been reduced during the past decade and yet there has
been no specific federal response to this situation.
Required investment in pollution abatement equipment. can affect
an industry in stmilar ways, but the effect will be smaller. in ma~-
nitude and of shorter duration than those resulting from the expan-
sion of the highway system, principally because when the capital
intensity of an industry is changed (as opposed to shipping costs),
the larger plants do not expand much.
Instead, they tend to raise
prices and accept a greater profit per unit.
But there are some
very small plants with exceptionally high costs of pollution abate-
ment which may not be able to survive.
First, because their prices
are already high; second, labor is unlikely to accept lower wages
and, third, mergers are not attractive since shipping costs are high.
If these small plants are to be kept in operation, a substantial
proportion of these differential costs would have to be absorbed on
a continuing basis by equity holders.
In practice, this is not
likely to happen and these plant& will cease operation unless they
receive assistance.
1. See, William S. Vickrey, Microstatics, (New York:
Brace & World, Inc., 1964), p. 334~ .
~arcourt,
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3-1~
Plant lute
Old plants may incur relatively higher abatement costs than
others.
First, they have generally uot been designed in a manner
v
which would permit easy installation of pollution control equipment.
This means that space might have to be created by moving other equip-
ment and/or buying new (frequently high priced) land adjacent to the
factory.l
Alternatively, a higher-priced type of equipment must be
used because it needs less space.
An electrostatic precipitator,
for example, requires more space and electric power than a fabric
filter; the installation cost of the former must therefore include
costs of making available the necessary space and electric power
supply.
In these cases, installation costs are augmented by the
necessity for more instrumentation, design engineering, and labor.
Existing recovery and disposal systems may need extensive
rebuilding to accommodate the new equipment.2
When a plant has been
built with no thought of controlling waste disposal, it may be diffi-
cult even to find, and more so to eliminate, many of the discharge
points.
If the technology is obsolete, it may often be accompanied
1. One source noted that the limited size of the mill site at the
U. S. Plywood-Champia pulp plant in Canton, N. C. necessitated in-
stallation of compact water treatment which was more costly but less
extensive than the lagoons treatment.. The Council on Economic
Priorities, Paper Profits: Pollution in the Pulp and Paper Industry,
1971, p. v-s. CMimeographed.)
2. The extraordinary costs of the Bethlehem basic steel making facil-
ity at Lackawanna, N. Y., one of'the nation's oldest, is among the
cases recounted in a recent comprehensive survey of industrial pollu-
tion abatement costs. See Gene Bylinsky, "The Mounting Bill for
Pollution Control," Fortune, July 1971, p. 130.
-------
---..---- --.-...-----.. .--.-"10..._..
f'
/
1---1
3Q13
bya :greater degree of poll\Jtion, reflecting the general inefficiency
and wastefulness of the ~ecnnology.
The higher costs of abating pollution are, of course, partly
caused by management having ignored environmental issues in the past.
,Some firms. have installed pol1ut1onahatement equipment before they
were required.
A number of firms have gone far beyond present re-
quirements, or have designed plants so that the necessary equipment
can be added later.l
Thus, many old establishments are forced into
heavy expenditure while others have already installed most of the
necessary equipment.
Differences in pollution abatement costs, on the basis of plant
age, may occur either because of the dtfficultiesof incorporating
pollution abatement equipment among old equipment which might have
to be moved or rebuilt, or for the related reason that different pro-
duction processes are in use.
It is unlikely that two processes would be discovered, each
with precisely the same costs and capital-labor ratio~ and so the
,reason for employing more than one process in capital intensive in-
dustries is that one is older than the other.
Usually, an innovation
requires less labor (and possibly less 'capital) because historically
the real cost of labor .has risen.
This means that a new process
1. One source indicates that Weye~hauser has been a leader in pol-
lution abatement since the early 1950's. Consequently, their ex-
penditures .on ,pollution abatement in the coming decade will be far
less than some of their less .concerned competitors. The Council
on Economic 'Priorities ,PaJ>er Profi,ts: 'Pollution in the Pulp and
,Paper Industry, 197L (Mimeographed.)
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3-14
involving a reduced labor force becOmes attractive as wage rates
increase, and, over a period of time, all new plants will use the
same new process.
As wage rates continue to rise, the older and
relatively labor intensive plant (in the sense of high payroll com-
pared to value added) becomes costly to operate in relation to the
new.
This means that the net worth of plants using the older pro-
cess declines year-by-year as their labor costs rise.
Eventually,
labor costs are so high that there is no return to the capital in-
vested, and the plant is closed.
In a relatively capital-intensive industry, it is quite usual
to use a number of processes.
The plants employing the most obsolete
processes may well have difficulty in absorbing high pollution costs,
since there is so little return over and above payroll and the cost
of supplies.
It is conceptually possible to find out how many such plants
exist by determining the number which have very low return to capital.
This information is not presently available from the Bureau of the
Census, however, so it may be necessary to obtain the information
from other sources or by means of a special study.
It would also
be necessary to determine if the pollution abatement cost for this
group significantly exceeds the industry average before deciding how
many might fail.
Again, if a number of these plants were failing
already, the rest might have to ,compare the total investment cost
of pollution abatement to their earning prospects in the years before
failure.
-------
3-15
This chapter concludes the outUne methodology designed to
predict unemployment cau,*," by the clo8ure of plants that have become
eeonomically non-viable as a result of pollution abatement require-
ments.
In addition, as discussed :£11 the following chapter, unemploy-
ment may result from plants clo8i:.i:1a. mel'ely because they cannot obtain
loans from commercial sources.
The three case studies in Chapter 5,
have been prepared to illustrate the procedures developed to estimate
unemployment in both types of situation.
-------
CHAPTER 4
THE PROBLEM OF FINANCING AND EVALUATIVE CRITERIA
Summary
1.
The number of potentially viable plants, i.e., those which could
pay for pollution abatement but cannot obtain commercial financing,
is very small for the following reasons:
a)
Many small plants are, in actuality, owned by prosperous
multi-plant corporations, and therefore have access to funds.
b)
Many others will be able to finance abatement through in-
ternal reserves, or, in closely held companies, by increasing stock.
c)
Others again have been in business a long time and have
established a credit relationship with one or more financial institu-
tions .
2.
Nevertheless, there are two possible reasons why some plants may
be potentially viable in the above sense:
a)
Rigid bank lending practices may fail to take account of
the plant's ability to recover the costs of abatement by increasing
prices.
The number of such plants is limited by the fact that en-
forcement generally starts with the largest concerns.
In this way,
prices have often begun to rise before the smaller plants start to
abate.
MOreover, as the non-viable plants cease operations, prices
will tend to increase anyway.
b)
Unfounded prejudice.
Despite a prevalent belief that small
businesses are apt to be victims of unfounded prejudice. evidence on
this score is so weak as to preclude estimation of the number of plants
that might conceivably be affected.
-------
4~2
3,
Th~ S~ll Business Admin~st~~~ion h8$ been set up to provide
loans to SlWill businesses and has th~ av.~nority to make loans for
~ollution abatement.
The would appear to 1;te no reason why the
~~yiro~ental Portection Agency shQQld ,et ~p an ~dditional program.
Evaluative Criteria
When funds are not available int~;t'nally, a firm must seek
financing from outside sources.
This may not be an easy matter,
since management must convince an often skeptical. outsider that the
plant's (or firm's) prospects for the future are sound.
The fact
1
~hat costs of pollution abatement are relatively easy to determine
is an advantage to the potentially viable plants under discussion in
2
tl).is chapter.
The assumption that commercial financing is available to
all Yiable firms presupposes certain conditions.
The' financial
community must be able:
1.
To predict the number of viable plants in each industry
2.
To determine which plants are viable, and
1. Pollution abatement is comparable to process innovation in a
n~~r of respects. First, the cost to the firm can be estimated
in advance. Second, process innovations, unlike product innovations,
are likely to succeed, because the firm has better control over all
aspects of the operation. Third, they generally involve 'standard'
machinery and techniques that other firms have used in similar
situations. For all these ~easons, pollution abatement is not a
speculative investment and is therefore easier to finance.
2. Obviously a government loan could only be an
assistance in cases where there was a likelihood
repaid. In 0 ther words, 10a1;1S are only s.u~ table
as opposed to non-viable, plants.
appropriate form of
that it would be
for potentially viable,
-------
4-3
3.
To act in an economically rational manner, that is, be
willing to make loans to all potentially viable plants.
To investigate the details of every loan application would
be a costly and time-consuming operation and therefore lending institu-
tions employ a number of evaluative criteria as a first means of
accepting or rejecting different types of businesses.
The criteria
may vary to some extent among institutions, but once lending practices
have been established, they are usually adhered to fairly strictly.
Possible applicants are isolated by these methods in the first instance
and each is then subjected to a more rigorous investigation before
1
being finally accepted, particularly so in the case of marginal firms.
General considerations include first, the borrower's credit
rating, and especially performance relating to any previous loan made
by the same institution.
Second is the location of the plant.
Banks
usually accept clients only from within their own community where
information pertinent to the loan can be readily collected and the
significance of changes in the community can be assessed.
If a bank
is 'large enough to support a great many loans, it has the advantage
of being able to subdivide applicants into different industrial groups
and thus utilize information about the industry to predict the effects
of new trends on an individual plant.
Two fairly broad types of evaluative criteria are generally
employed to assess the viability of an individual applicant:
payback
ability and liquidity.
1. "Marginal" is used here to describe those firms which do not con-
form to generally accepted evaluative criteria.
-------
.----'."'- ---.----..
-,~
4-4'
l"avback Ability
The profit and loss statement of a plant provides a ready
means' of estimating payback ability.
The 4bsolute level of profits
il1dicates whether or not a plant is capable of generating funds,
although the significance of this ,information diminishes with age.
Erratic profits over a number of years imply a lack of stability
arid a danger of bankruptcy and the plant is therefore generally
classified as a high risk.
Projections of sales and profits are required and their
relation to past growth as well as future prospects is also important.
'[,iquid"ity
A second consideration is the liquidity position of the
potential borrower.
If the plant were to close, the lender would
obviously be better off with "a plant that had a considerable excess
~f ~ssets over liabilities.
(This would be true even is the plant
~ere to experience difficulties in generating the predicted revenues.)
The debt-equity ratio is the first specific criterion used to estab-
lish the potential capital available if the plant should close.
The
current ratio (current assests/current l~abilities) indicates the
ease with which the plant can meet current obligations.
The cash
flow can be used as an aid in predicting changes in the stock of
capital available.
Many other aspects of the plant's operation will be investi-
gated, not the least important being an appraisal of management
capability, before an applicant can expect to qualify for a loan.
-------
4-5
Many commentators have contended that these rule-of-thumb
procedures have led banks and other ~inancial institutions to make
fewer loans to small business than are warranted, and that the
possible risks involved in lending to small business should be more
carefully scrutinized.
In other words, it is frequently believed
that unfair discrimination is practiced against small business.
One recent study concludes that "the availability of long-term and
1
equity capital cannot be considered adequate", while another author-
ity states that,
There seems to be little doubt that in
this competition (for financial resources) the
small business is under certain disabilities
that do not equally affect its larger counter-
part: it is more likely to need money; its
choice of sources is more limited; the terms
are generally more burdensome in ~espect to
security, interest, and maturity. .
At first glance, many facts may seem to support this contention.
For example, as Table 4-1 shows, small businesses generally have poorer
credit ratings than large firms and new businesses ~ave a lower rating
than old ones.
Banks generally prefer short-term to long-term loans.
According to the last complete survey of banking (1957), only 19
percent of all commercial loan money was lent fqr periods of over
3
five years, and only a small part of this long-term money went to
firms with assets under $1 million. Tables 4-2 and 4-3 show
1. Harold T. Smith, Equitv and Loan Capital for New and ExpandinK
Small Business (Kalamazoo, Michigan: W. G. Upj, ohn 1959), p. 5.
2. Edward D. Hollander and others, The Future of Small Business
(New York: Frederick A. Praeger, Publishers, 1967), p. 129.
3.
Harold T. Smith, Supra, p. 34.
-------
4-6
1
Table 4,:,1
INDEX OF RELATIVE TRAD.E CREDIT STANDING
OF BUSINESS BY SIZE AND AGE
(The proportion of businesses with good
credit in the surveyed populations - 100)
~e Classes Size Classes
All Sizes Small Medium Large
All ages 100 97 108 129
Under 5 years 88 86 97 NA
5-1P years 97 96 101 NA
Over 10 years 105 102 111 129
Source: A statistical study of data on credit standing of a large
~pd ~epresentative sample of business firms conducted for Robert R.
N~than Associ4tes, Inc.
1. Edward D. Hollander a~d others, 'l1\e Future of Small Business
(N~w York: Frederick A. Praeger, Pub1isq~rs, 1967), p. 130.
-------
4-7
that for the year in question only a small proportion of the loan
money available from commercial sour~es went to small business and
that the proportion became even smaller as the term of the loan increased.
One common reason for a low credit rating is that manage-
ment has not yet had time to demonstrate competence in running a new
operation.
One source notes:
Among the business births each year. . .about one
third will live to age five and about one fifth
to age ten, after which the survivorship rates
from year to year are very high. From this point
on, deaths are from 'natural causes': The sale
of the business as a going concern; liquidation
because of retirement, death, or other personal
reasons; the fermination of a lease or forced
removal; etc.
Since most new businesses are small, the selection criteria will tend
to be biased against small business.
The smaller plants in any given industry are apt to be
located in small towns or rural areas.
Consequently, they have the
disadvantage that they are usually dependent on small banks and, as
one source notes:
By any objective standard, the small banks appear
to be an economic anachronism. They are over-
liquid and overcautious. Their business lending
is usually confined to long-established customers.
Many are also painfully understaffed and unequip-
ped to handle a complex or unusual loan request.
In general, the small ba~ks serve their local
communities very poorly.
1. Edward D. Hollander and others, The Future of Small Business
(New York: Frederick A. Praeger, Publishers, 1967), p. 107.
2. Sanford Rose, "Are Those 11,400 Banks Really Necessary?"
Fortune, November, 1970.
-------
4-8
Table 4-21
DISTRIBUTION OF TOTAL BANK COMMERCIAL LOAN MONEY -- 1957
Term of Loan Small Business Large Business Total
Under 1 Year 21.0% 41. 0% - 62.0%
1 - 5 Years 5.7% 13.3% 19.0%
Over 5 Years 5.1% 13.9% 19.0%
Table 4-3
PROPORTION OF BANK COMMERCIAL LOAN MONEY
GOING TO SMALL AND LARGE FIRMS ACCORDING TO
. TERMS OF THE LOANS -- 1957
Tenn of Loan Small Business Large Business Total
Under 1 Year 34.0% 66.0% 100%
1 - 5 Years 30.0% 70.0% 100%
\
Over 5 Years 27.0% 73.0% 100%
1. Tables 2 and 3 were based upon material cited in Harold T.
Smith, Equity and Loan Capital for New and Expanding Small Business
(Kalamazoo, Michigan: W.E. Upjohn Institute for Employment Re-
search, 1959), p. 34. .
-------
4-9
Larger banks are more productive, can offer a wider range of services
and can adopt a more flexible attitud~ with regard to loans than
smaller banks which cannot afford to risk the failure of even a small
number of loans.
These remarks can be formalized by listing four reasons which
may contribute to low credit ratings given to small firms.
It should be
recognized, of course, that the first two are valid market considerations
(and the third, misinformation, might be justified as well) which combine
to discourage banks from lending. to small businesses.
1.
2.
3.
4.
Borrowing costs
Uncertainty
Misinformation
Irrational prejudice
Borrowin~ Costs.
These costs are incurred when the lender
is obliged to investigate a loan application and may be considerable
in the case of a new business without an established credit rating.
However, as plants affected by pollution abatement requirements have
generally been in existence for some time, this should not be a
serious problem here.
Uncertainty.
Small firms are often closely tied to a few
suppliers and a few principal customers.
Any change in the pattern
of dealings with one of the suppliers or customers can have a major
effect on the firm's profits.
Thus small plants are likely to have
a more volatile profits record than large firms and are more liable
to go bankrupt in adverse business conditions.
This uncertainty
represents a serious risk from the lender's point of view.
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4~10
Misinformation.
In moat instances, lending practices have
been built up over a number of years and financial institutions are
reluctant to depart from established precedents.
The disadvantage
~fthis system is that established procedures may be inadequate to
assess an unusual or a new situation.
For example, victims of natural
disasters have often experienced great difficulty in borrowing money
from their local banks to restart their businesses because they were
in an unusual situation which had not been envisaged by the bank in
devising a framework of lending practices. This problem was so
serious when it did occur, that the Small Business Administrationl
~as a program to provide funds in these circumstances.
Pollution abatement regulations present a new situation
insofar as similar legislation has never before been enacted.
Consequently, applications for loans may be rejected by banks because
tse effects of industry-wide prices on the prospects of an individual
plant are imperfectly understood.
In fact, the effect will be the
same as that of an excise tax.
Irrational Prejudice.
In view of the above discussion,
it seems probable that accusations of irrational prejudice are un-
warranted.
Indeed, a Federal Reserve study supports the position
that such prejudice is minimal.
...bankers tend to subject almost all borrowers
to the same general test of credit-worthiness,
1. For a further discussion of the Smali Business Administration,
see below and Chapter 6.
-------
4-11
but they have found from experience that certain
lines of business and types of collateral ~ffer
possibilities of greate~ risk than others.
Edward D. Hollander suggests that, by and large, the general
criteria used by financial institutions may miss some special cases,
but feels that "tightly individualized evaluations" would be needed
to "distinguish the promising prospect from the inherently poor risk. ,,2
This comment can be explained if small plants do indeed
involve a higher risk than large firms.
I.n each case the observed
variance could partially be explained by i.nformation about the indi vid-
ual concern.
If the overall variance is Hmall, the additional informa-
tion will have little effect in separatinf~ the good risks from the bad.
But if the overall variance is large, it :LS much more likely that more
intensive investigations will bring to light plants that are potentially
viable.
Short-Term Effect
In any case, assuming that irra1tional prejudice may exist to
some extent, it would result only in a short-run or transitional problem.
If financial institutions are too cor.lservative and inflexible in their
lending practices, an exessive number of lbusiness failures may occur
among potentially viable firms and the ree1Ulting unemployment would be
1. U.S. Congress, Select Committee on Small Business, Financing Small
Business, Report to the Committees I)n Bank:ing and Currency by the
Federal Reserve System, April 1958. Cited in Edward D. Hollander, ~
aI, The Future of Small Business, (New York: Federick A. Praeger, Inc.,
1967), p. 129.
2. Edward D. Hollander and others" ~~ture of Small Business
(New York: Frederick A. Praeger, PublisJaers, 1967), p. 135.
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4-12
a cost to society unless the factors of -production could be shifted
itlimediately to other industries.
In the meantime, however, the supply of the product is
't"educed by more than the optimum.
The ~hortfa1l will induce an
increase in price as suppliers discover that price, reSistance has
lessened.
The price increase will be faster than in optimal con-
ditions, and the rapid improvement of the industry's situation
will prompt a new assessment of firms' prospects.
In other words,
new plants will be started sometimes by the same people who were
~reviously refused loans, but whose prospects have now improved
owing to the new, higher prices for the product.
Activity of this
kind is well established in "folding table" businesses in construc-
tion and repair industries where both capital and scale are so small
that operators can move into and out of business with equal facility.
As well, enforcement usually begins with large companies:
as they abate, prices rise, i.e., even before small plants abate.
All of the problems referred to above concern. the economy
as a whole, and a practical solution would require a general program
rather than piecemeal enforcement by individual agencies whose main
interests and competence lie elsewhere.
In fac~ the Small Business
Administration was funded for the purpose of circumventing some of
these problems and is concerned with the question of financing small
businesses which have been unable to draw on commercial sources.
Consequently, this agency is better informed about conditions in any
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4-13
given industry than most banks (especially small town banks), is able
to consider individual cases more carefully, and can thus evaluate
doubtful prospects more precisely than a commercial institution.
In the circumstances, it would seem unneccessary for the Environ-
mental Protection Agency to set up a special program to handle the
loan applications of potentially viable plants, especially as they
are expected to be few in number.
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C ,H.A P T E ,R
5
CASE STUDtBS
The following three case studtes 'have .been prepared for
:
~~par.ate consideration so that eaah~y.stand ,alone and provide
cO;mPrehensive information without reference to companion pieces.
Si,nce the same, or similar, factors are being considered in each
case study, the repetition of a nuMber of statements is inevitable
and deliberate.
The studies concentrate upon the costs of air pollution
only; full studies of all connected and .ncil1ary costs relating to
,o~her forms of pollution control do not come within the scope of the
present contract but would, of course, have to be included in an
~ct~al survey of the econ~c effects of pollution control legislation
u~o.~ industry.
Chapter 1, Methodology (Part I): Outline, should be read.
before the case studies.
Very briefly, the salient points to be noted
are as follows:
1.
Plants will abate unless the initial outlay
involved exceeds the di,counted cash flow less
1
salvage value of the plant.
1.
This can be expressed ~th~tically a, follow8:
PA > OCF + ADCF - S
where
PA - initial outlay for pollution abatement,
OCF - anticipated discounted cash flow prior to
abatement regulations,
4DCF = change in discounted cash flow because of
abatement regulations, and
S = salvage value of plant.
.
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5-2
2.
Accuracy in estimating plant closures within a particular
industry is not importan~ since the major problem for
"
policy purposes is to estimate the nationwide impact on
employment.
Only if the latter "ranae of estimates is too
broad to decide upon an appropriate federal response, need
more accurate estimates be made for specific industries.
.
3. A crude esttmation procedure based on ~Badily available data
is proposed as being the most tmmediate and cost-effective
means of esttmating the magnitude of unemployment resulting
from"pollution abatement legislation.
It will indicate the
II
range within which closure can be expected within a given
, I
industry.
By summing the low and high estimates for closures in
each industry, a broad range can be determined for the
econ~ as a whole.
Some plants will be situated in areas
of chronically high unemployment and it will be advisable
to determine the geographic locations of closing plants for
the industries most affected.
4.
Prices will increase rapidly if industry control is
concentrated, if demand is price inelastic, or if
the industry is labor-intensive.
In the latter instance'
output may decrease if aemand is price elastic.
-------
5.
6.
5..3
(b)
Price increases will be delayed if demand is
price elasUc and the industry is capital intensive
with excess capacity.
(a)
Plants may cease operations if they anticipate
operating for only a few years.
An estimate is
given for the period ~f time required to recoup.
investment in pollution abatement.
(b)
Plants may also cease operations if their differential
cost of abatement is sufficient to exceed the anti-
cipated net present value of the plant.
Separate case studies have been prepared for indus-
tries which are labor, capital and resource intensive
because consideration of these extremes is essential
to the discussion.
(It should be recalled that pro-
cesses used in resource intensive industries are
either labor or capital intensive.)
-------
CASE STUDY #1:
GRAY IRON FOUNDRIES
.
Objective
This section illustrates the application of the methodology deve-
loped to estimate the order of magnitude of unemployment in a labor in-
tensive industry.
The data are, in many cases, incomplete or outdated
and therefore
are used for illustrative purposes only.
Context
The gray iron foundry industry has been selected as an example of
a labor intensive industry since its payroll (at $956 million) is 63 per-
cent of value added (at $1,543 million),l well above the 47 percent figure
for all manufacturing (Table 3-1).
In addition, the major portion of
costs of materials2 (of $1,075 million) is for supplies of pig iron.
Yet,
the industry calls for such a small proportion of the total supply avail-
able in the U.S. that an increase or decrease in the output of foundries
does not affect the price of pig iron.
Consequently, for analytical pur-
poses, even the cost of materials can be considered akin to labor in that
its price is unaffected by changes in foundry output.
Industry Economics
Gray iron foundries produce castings for diverse purposes.
In most
cases castings have low value per unit weight, with high transportation
1. Bureau of ~e Census, 1967 U.S. Census of Manufacturing: Industry
Statistics, Vol. II (Washington, D.. C.: GPO, 1970), Table 4, "General
Statistics, by Employment Size of Establishment: 1967" (SIC 3321)
2. Cost of materials is only $1,075 million, or 41 percent of the value
of shipments of $2,738 million. Ibid.
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GIF..2
~~09tS in relation to this value.
Matket size is therefore largel~ dic-
tat~a by transportation costs.
plants of ~idely varying size.l
Indeed, there are approx~ately 1,000
The potential effect of differing region-
81
or international regulations is thus minimal.
Closures of small plants occur when transportation costs increase
or When a more capital intensive process is developed.
In each case,
larger plants are able to expand their markets at the expense of smaller
ones.
The failure rate for gray iron foundries has been about 25 a year
for the past ten years (2-1/2
percent of the industry per year).2
The real growth in the gray iron foundry value of shipments was
5.4 percent per annum from 1958 to 1967.
This is similar to the real
srowth of value of shipments of all manufacturing of about 5.5 p~rcent.3
Pollution Abatement Costs
Gray iron foundries emit carbon monoxide and particulates;
abate-
ment equipment consists of afterburners and wet scrubbers or fabric fil-
terse
By~ 1976, it is estimated that the industry will have invested
~317.3 million to achieve pollution abatement.4
Once this invesbnent
1. In 1967, there were 1,061 plants. Of these, 126 employed no more than
four workers, while five employed more than 2,500.
2. Bureau of the Census, "Coonty Business Patterns," cited in U.S. Depart-
ment of Health, Education and Welfare, -Ecqnomic ]mpact of Air Pollution
Controls (Washington, D.C-. : GPO, 1910), p. 76.
3. U.S. Department of Health, Education and Welfare, Economic ]mpact of
Air Pollution Controls on Gray Iron ~bUndries Industry Oiashington, D. C.:
GPO, 1971), Table 18, p. 46.
4. Report of the Adminis.trator ..of the Envi1:'omnental .Protection Agency,
The Economics of Clean Air (Washin8ton, n. C.: GPO, 1971), p. 4-112.
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GIF-3
has been made the annual cost to the industry will be $108.2 mill~on.l
Part of this represents amortization of the investment cost ($63.6 million);2
all the remainder represents annual operating and maintenance costs ($44.6
million) .
The study will utilize the following percentages of value of ship-
ments, which is estimated at $3.5 billion:3
Average annualized investment cost:
1..8%
1.3%
Annual operating and maintenance costs:
Total annualized cost:
3.1%
It should be made clear at the outset that each of these figures
is being revised by EPA;
moreover, costs of water pollution abatement,
etc. are not included.
The results therefore, may ~ be indicative of
the actual number of closures.
1. Report of the Administrator of the Environmental Protection A~ency,
The Economics of Clean Air (Washington, D. C.: GPO, 1971), p. 4-112.
2. If an amortization period of 10 years and interest rate of 14 per-
cent are assumed, annualized costs are one fifth the initial cost. 1E!2.
3.
.!2!.2., p. 4-20.
4. U.S. Department of Health, Education and Welfare, Economic Impact of
Air Pollution Controls on Gray Iron Foundries Industry (Washington, D. C.:
GPO, 1971), Table 18, p. 46.
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'GIF-4
Econ~1c~alysis
1'.JJ; Price Changes
There are few barriers to raising the p~ice of castings in response
to an indhstry-wide increase rn cost.
FiTst, castings have relatively
Daw"substitutes.
In same cases alumi~tim'could:be u,ed, but the
pdllution abatement costs for aluminum aTe even higher than for gray
iron foundries.l On the other hand, castings are often complemented by
other products in order to provide the final commodity (e.g., cars).
Finally, castings are often a small portion of a customer's total budget;
therefore, price changes are of limited concern.
Demand for castings,
then', is relatively price inelast-flc.
Demand is particularly inelastic
i~the short run since any substitution would usually require a consi-
derable period of time to effect. Consequently, customers will bear a
2
large proportion of pollution abatement costs, even in the short run.
Since gray iron foundries are labor intensive, it is assumed
that supply is price elastic in both the short-and long-run.
This
11Iefihs that the industry exhibits essentially constanf: unit costs over
a'wide range of output.
In this special, case of constant unit costs,
the price, irrespective of quantity demanded, must rise by the full in-
c~~ase in the exogenous pollution abatement costs.
Since the average
1. Report of the Administrator of the Environmental Protection Agency,
'!be Economics of Clean Air (Washington" D.C.c. GPO, 1971),pp. 4-20.
2.
See Chapter 2.
-------
~F~
annualized pollution abatement cost is estimated to amount to 3.1 percent
of value of shipments (see Pollution Abatements Costs, above), the price
is likely to rise by approximately the same amount.
The quantity demanded is determined (in the case of price elastic
supply) by the price elasticity of demand for the product.
Since demand
1s relatively inelastic, the reduction in value of shipments would be
small, even in the absence of industry growth.
Real output is increasing,
however, by about 5.4 percent per annum.
(See Industry Economics, above).
The established demand will prevent layoffs, as the price rises
rapidly until the entire cost of pollution abatement, estimated here at
3.1 percent of value of shipments, is covered.
Expansion will be deferred
during this period of price absorption which is unlikely to last for more
than a year or two altogether.
2.0
Differential Cost
Although most plants in the industry will have little trouble in
passing on costs of pollution abatement, individual plants with high costs
face a more difficult situation
in that their customers may have access
to cheaper alternative sources of
supply, namely those plants with lower
abatement costs.
The differential will, therefore, have to be absorbed
by the equity holders,
who must decide whether to go out of business or
to accept the increased cost burden.
1. Those plants whose costs are lower than the average may gf course,
profit by the regulation. See Chapter 3.
-------
._-~.-
GIF-6
If a plant does go out of business, there may be additional
tt~nBition costs which the community as a whole must bear, principally
the cost of prolonged unemplOYment for the workers concerned.
2,1
Cost Differentials for Foundries
There are three major reasons for differential costs:
size of
the plant, processes employed and legislative requirements.
'!be two
latter causes are discussed at length in Chapter 3 and Appendix B.
'!be
question of size is the more important of the three and the only one
pertinent to this case study.
Annualized investment costs for pollution abatement are e.sti-
mated to vary from 0.7 percent of value added for large foundries to
3.2 percent for the smallest plants.
But the industry's average annua-
lized investment cost of pollution abatement is 1.8 percent of value of
shipments. (See Industry Economics, above).
'!bis figure provides a
rcugh approximation to expected price increases.
Since large foundries
have lower costs, we can overstate the probable damage by assuming that,
at worst, they may have an increased return or profit ofl.l percent
once prices have fully risen, while small foundries will suffer a per- .
manent loss of up to 1.4 percent (i.e., 3.2 percent less 1,8 percent,
the average) of the value of shipments,l
For purposes of discussing
..,
1. The provisions of the corporate income tax will reduce both profits
and losses.
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GIF-7
whether small foundries will decide to accept this cost,. or go out of
business, they are classified as being "lonStrun" and "short-run" viable
before invesenent in pollution control.
2.1.1
Lonse-Run.
Before deciding whether to absorb the 1.4 per-
cent annual cost or to go out of business, management must estimate the
difference between actual return to capital (i.e., before pollution con-
trol invesenent) and the potential return to this capital in alternative
uses (i.e., the opportunity cost of the capital employed).
If this dif-
ference is greater than the pollution abatement cost, the plant will in-
stall the necessary equipment.
Once this capital is committed, it will
have no further efffct on the plant's actions.
A rough estimate of the
gross return on capital in gray iron foundries was calculated from 1967
Census of Manufacturing data as 22 percent of value of shipments.l
Financial statistics providing a guide to salvage value are not
available on a 4-digit SIC industry basis.
Nevertheless, a rough esti-
mate can be made:
the building and land, for example, can probably be
converted to alternative uses.
I
Beyond that, ,however, the salvage value
of the operation (plant, equipment, good will) would appear to be negli-
gible.
At a conservative estimate (in order to overstate closures),
1. The. total value added for the industry is $1,543 million. The total
payroll of $965.3 million is subtracted from this, leaving a total of
$577.8 million for the gross return on capital. This residual is now
divided by the industry value of shipments of $2,637.8 million; the re-
sidual is 22 percent of the industry value of shipments. Bureau of the
Census, 1967 U.S. Census of Manufacturing: Industry Statistics, Vol. II
(Washington D.C.: GPO, 1970) (SIC 3321).
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GIF-&
it i~ ~ss~ed that the plant WQ~~d lQ~e a net ~eturn of roughly 10 per-
~en~ Rf tqe value of shipm~nt~ py ceasin$ QP~r4tions.l Since this figure
is mu~p g~eater than the necessary expenpiture on pollutiori control (i.e.,
b~ ~e.very sma~lest plants, of 1.4 percent of the value of shipments),
~~~~-~n viable plants will have no reasOn to clQse down.
2.1.2
Short-Run.
A different an~~ysis must be employed for plants
which will cease operation in the near f~ture even without incurring pollu-
tion abatement costs.
In such situations, the costs cannot be looked at
in terms of annual costs since these plants will nQt remain in operation
fOJ; the 10-year estimated life of the equipment upon which the costs are
calculated.
The highest annualized invescnent cost is estimated at 3.2 percent
of value of shipments.
That is equivalent to an initial investment of 16
percent of one year's value of shipments.2
It may be that none of this
1. Internal Revenue Service (IRS) data for the comparable 2-digit SIC
industry (Primary Metal Industries) indicate that the sum of rent, in-
terest and taxes in 1967 amounted to $1,768 million, or about 4.4 percent
of .business receipts of $40,154 million. U.S., Department of the Treasury,
Internal Revenue Service, Statistics of Income. 1967: Business Income
Tax Returns (Washington, D.C. : GPO, August, 1970), p.9.
!his figure (4.4 percent) probably underst~tes the return which could
be made in an alternative use, particularly for the smaller, failing es-
tablishments with which this study is cQncerned. To be on the conservative
side, then, the figure has been increased tQ about 12 percent, leaving a
ret\1.rn above opportunity cost of about 10 percent.
2. The investment cost was obtained originally as a dollar cost. This
was annualized by dividing by five (interest rate of 14 percent, and
amortized over 10 years).
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GIF-9
capital cost can be recovered in the first year, but thereafter recovery
is estimated to be at the rate of 1.8 percent per year,
i.e., the average
cost of capital for the industry (see 1.1 above).
The current closure rate is approximately 25 plants per year, (see
Industry Economics, above), and all the failures are small plants.
Assume
that the 25 plants destined to close within a year in any event consider
the alternatives of installing equipment or ceasing operation immediately.
According to the rough estUnates given in 2.2.1 above, net return to capi-
tal from continuing operations that would otherwise be lost is about 10
percent of the year's sales.
The increased cost of operating for the first
year as a result of installing abatement equipment is 16 percent of sales.
It
is reasonable to conclude that the 25 plants with a potential life of
no more than one year would close immediately.
The 25 plants with an estimated life of two years will have a net
return over that period of 18.77 percentl of one year's sales by remaining
in business, while incurring costs of 14.32 percent2 for abatement.
Since
the equivalent of 18.77 percent of one year's sales is lost if operations
cease, most of this second group will have a limited incentive to continue.
1. 18.77 percent is equal to a return of 10 percent of the first
year's sales, plus 10 percent of the second year's sales; the latter
figure is discounted at the rate of 14 percent (i.e., the discounted
figure amounts to 8.77 percent).
2. 14.32 percent is equal to a cost of 16 percent of one year's
sales for the initial investment, less (in the second year) 1.8
percent discounted at the rate of 14 percent (i.e., 1.66 percent).
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GIF-IO
in all, it may be assumed that some .35 plants will cease operations, and
iineUlp10ym~nt resulting therefrom would be perhaps 150.
3.0
Sensitivity Analysis
As a rough judge of the acceptability of these estimates, a sensi-
tivity analysis can be performed by varying each number in turn to deter-
mine its effect on the overall conclusions.
3.1
Stability of Price Considerations
There is no reason to doubt the accuracy of the est~ated average
annual pollution abatement costs (3.1 percent of value of shipments).
For
the sake of the sensitivity analysis, however, an extreme case has been
taken, and the assumption made that pollution abatement costs have been
tripled for gray iron foundries -- i.e., 9.3 percent of value of shipments
per annum.
The incidence would be the
same :
prices would rapidly rise by
9.3 percent over an extended period of tUne.
It is probable, however, that
some employees would be laid-off temporarily (for a year or so), and for
long-run viable plants (before abatement), the net impact would be reduced
profits for several years.
The impact for short-run viable plants (before abatement) is rather
different.
Assume first that the absolute cost differential remains the
same:
small plants could lose about 1.4 percent of value of shipments per-
manently, in addition to the temporary losses described above. The cost
for those plants having an expected life of only one year would increase
to about 27 percentl of sales, a much higher figure than the 10 percent
net return to be lost by ceasing operations.
1. The initial invescment cost (27 percent) is five times the annualized
investment cost of 5.4 percent.
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GIF-ll
Table 1 provides a rough illustration for comparative purposes.
Plants with an expected two-year life will probably also close since
the costs of pollution control would be larger than the potential
gains from utilizing immobile equipment.
Similarly, most establish-
ments contemplatinR a three-year operation will clbse.
On the average,
the costs will be approximately as great as the financial benefits to be
gained from continuing.
A life span of four years or more is necessary before
a plant has an incentive to continue under these circumstances.
Table GIF-1
SHORT-RUN VIABILITYl
Years of Costs Accumula5ed Benefits4 Accumulated Net
Operation Incurred2 Costs Benefits3 Incentive2
1 28.3 28.3 11.3 11.3 -17.00
2 1.3 29.44 13.1 21. 79 - 7.65
3 1.3 30.44 13.1 31.87 + 1.43
1. All figures are expressed as a percentage of one year's value of
shipments.
2. Initial invescment cost is assumed to be 27 percent of one year's
value of shipments. Each year operating and maintenance charges amount
to 1.3 percent of the year's value of shipments.
3.
Present value, assuming a discount rate of 14 percent.
4. Benefits include 10 percent of value of shipments (i.e., the re-
turn above opportunity costs) each year, and a price increase of 1.3
percent the first year and rising to 3.1 percent in succeeding years.
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GIF-l2
To summarize, When avera~e costs are tripled, the number of
clo~ures caused by pollution abatement requirements is approximately
doubled (i.e., from about 35 to about 70), with unemployment slightly
more than doubled to just over 300.
Even so, the average life of those
plants which ceased operations would be cut by no more than two years.
3.2
Differential Pollution Abatement Costs
Estimation of the differential costs of pollution abatement is
more susceptible to error than estimation of average costs.
In order
to assess the possible effect of such misestimation on the smallest
foundries, an extreme case is postulated here, using tripled figures,
i.e., it is assumed that annualized investment costs are 9.6 percent of
the value of shipments rather than 3.2 percent.
For long-run viable plants (before abatement), it is here assumed
that roughly 1.8 percent (i.e., the industry average costs) will be re-
couped, leaving an annual loss of 7.8 percent of value of shipments.
Since this is somewhat smaller than the 10 percent net return per year
(see 2.2.1., above), long-run viable plants will have some incentive to
remain in business.
During their expected life span, short-run viable plants (before
abatement) must recover the equivalent of an initial investment of 48
percentl of one year's value of shipments.
Us ing the same method of
1.
48 percent is five times the annualized investment cost of 9.6 percent.
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GIF-13'
calculating, a plant having an expected life of five years would incur
a cost of about 40 percent of one year's sales for abatement but the cost
would now be balanced by earnings.
In short, when differe~tial costs are
tripled, the number of closures caused by pollution abatement requirements
is increased four-fold from 35 to approximately 125, and unemployment
increased five- or six-fold to say 1000.
This indicates that precise estimation of the costs of particular
groups of plants, at least insofar as they substantially exceed the ave-
rage, is important.
Cost estimates for the gray iron foundries were
developed by EPA using models of six different sizes of plants, the smallest
1
having annual sales of $400,000.
About one-third of the existing foun-
dries, however, are even smaller (some 350 plants);
half of these have
annual sales averaging only $30,000.
For these plants, it seems unlikely
that invesement costs will decrease by the
same factor as sales.
In
fact, one of the reasons for a low volume of sales is that some plants
operate only sporadically, although their capital equipment may be as
extensive as that of plants operating continuously and having a much
larger annual value of shipments.
Although there are many small foundries, their output is so limited
that it can be assumed that their increas~d costs will have little effect
on the industry's average costs2 or on price increases.
Suppose that a
1. U.S. Department of Health, Education and Welfare, Economic Impact of
Air Pollution Controls on Gray Iron Foundries Industry (Washington,D.C.:
GPO, 1971), p.43.
2. Thus, it can still be assumed that the increased price owing to the
cost of pollution abatement will amount to 3.1 percent. (Pollution
Abatement Costs, above).
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GIF-l4
plant with annual sales of $30~,OOO must inves't half a~ much for pollution
abatement as the model $400,006 annual sales foundry. the annualized
invesonent cost would be at least 15 percent of sales~
Obviously, in
tne~e circumstances a small foundry would close immediately.
there are
some, 350 plants with annual sales of le'ss than $400,000.
It is clear that
some, perhaps all, are liable to face costs that will force them out of
business, but in the absence of more refined data it is not possible to
provide a more precise estimate.
In this extreme case, unemployment could
range as high as, say, 4,000.
3.3
the Effect of Misinformation
As outlined in Chapter 4, it is possible that financial institutions
may reject applications for loans because they do not recognize that pollu-
tion abatement requirements in an industry will result in price increases.
The effect of this misinformation might be that the entire cost of pollution
abatement has to be borne by the plants themselves.
Small plants are therefore assumed to absorb an annual cost of 4.5
percent of value of shipments each year if they are to continue.l
For long-
run viable plants, it has been assumed that average net return is about
10, percent of value of shipments.
While a permanent loss of 4.5 percent
of value of shipments is large, there is still some incentive for plants
to remain in business.
1. Annualized investment costs are asswmed to be 3.2 percent of annual
value of shipments, while operating arid maintenance costs run at 1.3 per-
cent. See Pollution Abatement Costs and Cost Differentials for Foundries
above.
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GIF-l5
For short-run viable plants the situation is different.
At
least two years' return would be requi~ed to offset the costs of pollu-
tion abatement.
If 25 plants close every year, about 50 would close
immediately rather than abate.
This figure should be compared with the
25 to 35 plants which would close even if industry price increases were
considered.
(See Short-Run,. above).
3.4
Uncertainty
The above discussion has concerned the number of plants which would
close rather than pay specific levels of pollution abatement costs.
A
banker, however, must determine which plants will close.
As pointed out
in Chapter 5, this is particularly difficult when either price elasticity
or cross-elasticity of demand is high.
Neither appears to be the case
for the gray iron foundry industry.
If this assumption is correct, the
effect of uncertainty is small.
3.5
Summary
Differential pollution costs are the most sensitive figures in
establishing the number of closures likely to result from pollution abate-
ment requirements.
Information concerning one important category of
plants (i.e., those with the smallest annual value of shipments) is not
available for the gray iron foundry industry.
If it is assumed that
average abatement costs as a percentage of value of shipments for this
category will not exceed the costs for the model with annual sales of
$400,000, only 35 foundries will be immediately and directly affected.
On the other hand, if investment costs, as a proportion of sales, rise
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GIF-16
even modestly as the size of a plant decreases, the number of failures
w'ill be considerably higher.
In the absence of accurate information,
one can reasonably speculate that approximately 350 foundries may be
forced to close down.
In concluding, it should be re-emphasized that the figures cited
above are for illustrative purposes only.
-------
CASE STUDY 112:
PORTLAND CEMENT INDUS TRY
Objective
This section illustrates the application of the methodology de-
veloped above to a capital intensive industry.
The data are, in many
cases, neither current nor complete, and are therefore used for illus-
trative purposes only.
Context
The Portland cement industry has been selected as an example of
a capital intensive industry since the payroll ($248 million) is 30 per-
cent of value added1 ($812 million), well below the 47 percent figure for
all manufacturing (see Table 2-1).
Cost of materials ($493.2 million)
I.
is also a very small proportion of value of shipments, and the materials,
including chalk,' clay, limestone and shale, are readily available. 2
Industry Economics
Portland cement is a binder in concrete and, therefore, the most
widely used construction material in the U.S.
It is produced by either
a wet
or a dry process, distinguished by whether the raw materials are
introduced into the cement kiln as a wet slurry or as a dry mixture.
1. U.S., Department of Commerce, Bureau of the Census, 1967 U.S. Census
of Manufacturing: Industry Statistics, Vol. II (Washington D.C.: GPO,
1970), Table 4, "General Statistics, by EmploYment Size of Establishment):
1967" (SIC 3241).
2. Cost of materials is just $493.2 million, or 35 percent of the value
of sbipments of $1,247 million. ~.
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Cement-2
Since cement has low value per unit weight, transportation costs
are high in relation to value.
Markets
are, therefore, restricted by
trdnsportation to a radius of 200 to 300 miles.
There are 197 existing
plants of which 115 employ between 100 and 249 workers;l
since capital
costs are high, size differences are not significant.
The potential
effect of differing regional or international regulations is minimal.
The trend in cement plants in recent
years has been towards
larger kilns, computerized operations and improved integration of the
raw mill, the kiln, the clinker gtinding and the associated storage and
flandiing equipment.
As wage rates have increased, the industry has con-
ttnued to introduce labor-saving equipment.
From
1963 to 1967, while
butput increased nearly 10 percent, the number of employees dropped
from 34,900 to 32,400, a 7 percent decrease.
During these years, the
industry became more capital intensive and more efficient.
The new plants, therefore, can compete effectively with the
older (in terms of price) because the newer plants have a greater per~
centage of their cost fixed as equipment and must employ it to earn a
return.
The older plants have greater proportionate variable costs;
their labor costs are estimated to be three times those of the newer
mil1s.
The costs must be cut primarily thrbUgh decreasing output.2
1. U.S., Department of C~erce, Bureau of the Census, 1967 U.S. Census
of Manufacturing: Industry Statistics, Vol. II (Washington, D.C.: GPO,
1970), table 4, "Genetal Statistics, by Employment Size of Establishment:
1967" (SIC 3241).
2.
"Review and Fotecast:
Cetrtent", Pit and QUarry, January 1971, p.77.
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Cement-3
The newer plants can absorb more transport cost and have larger market
areas to serve because they have lower barrel costs that continue to
fall as the operating rate moves toward capacity.
Therefore, the new
and efficient plants are probably operating near capacity in order to
capture part of the market of older, less efficient plants.
The older plants finally reach a stage at which the capital
brings no return, and are abandoned or modernized.
Between 1967 and
1970, 16 plants were closed while 11 plants were opened and 15 plants
were modernized.
In 1970, the net capacity dropped 2 million barrels
from the all-time high of 518 million barrels.1
Since sales of Portland cement are tied closely to construction
activity, projections
would likewise be based on this kind of activity.
Construction is expected to increase, though probably erratically, and
this will provide new markets for cement.
The variability in demand
(as opposed to elasticity) is at all times a problem, but it will not
be affected by pollution abatement expenditure.
Pollution Abatement Costs
It should first be reiterated that this analysis is concerned
only with air pollution abatement costs and does not include all costs
of environmental protection.
1. "Review and Forecast: Cement", Pit and Quarry,
In 1970, eleven plants were shut down while two new
and three new kilns were installed in older plants.
planned expansion activity involves installation of
equipment, pp. 82-86.
January 1971, p.80.
plants were opened
Most of the 1971
pollution control
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Cement-4
The three major sources of particulate emissions in a Portland
cement plant are:
raw material dryer (for the dry process), rotary
kiln and clinker cooler.
The wet process requires an electrostatic
precipitator for the kiln, while the dry process requires glass fabric
fil ters.
It is estimated that 13 percent of all cement plants will re-
quire completely new systems
while 63 percent are already partially
controlled and 24 percent fully controlled.i Approximately $50 million
have already been invested by the newer plants; the annualized costs
are $10 million.2
In addition, $8 million are currently spent on
operating and maintenance costs (i.e., for air pollution abatement).
An additional investment of $103 million will be required fo~
air pollution abatement by the partially or uncontrolled plants.3
This
amounts to $20.6 million in annualized costs and an additional $16.7
million per year in operating and maintenance costs.
The total ad-
ditional annualized cost of pollution abatement is thus $37.3 million.
Ii all costs are taken into consideration, the annualized
costs of pollution abatement are about 4.4 percent figure of value of
ohipmen~s for the industry a8 a whole ($1,247 million).
Of this, about
1. Report of the Administrator of the Environmental Protection Agency,
~ Eco~ics of Clean Ai~ (Washington, D.C.: GPO, 1971), Table 4-4, p. 4-34.
2. If an am:>rtization period of 10 years, and interest rate of l4,p9rcent
are assumed, annualized costs are one fifth the initial cost. Ibid.
3.
Ibid., pp.4-17.
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Cement-S
1.4 percent has already been incurred and an industry adjustment made.
The 4.4 percent can be divided into two parts:
2.5 percent represents
average annualized investment costs of pollution abatement, and the
remaining 1.9 percent operating and maintenance costs.
No information is presently available to indicate that the cost
of pollution abatement is high as a proportion of value of shipments
for obsolescent plants.
Economic Analysis
1.0
Incidence of Average Pollution Abatement Costs
The demand for cement is relatively price inelastic;
that is,
the quantity demanded will not vary very much in response to changes in
price.l
Cement is used both in ready-mix concrete and in various forms
of construction.
For most uses, there are few important substitutes or
complements.
The price of cement tends to be a small portion of the
total cost of construction.
Demand is particularly price inelastic in
the short run since builders are usually locked into specific designs
requiring specific amounts of concrete.
Prices will therefore increase
rapidly to cover the costs of most plants.
1. The quantity demanded varies considerably in response to changes
in construction activity, but once decisions are made to begin con-
struction, cement is used more or less regardless of price. A change
in the price of cement will not have much effect on decisions to com-
mence construction.
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Cement-6
1.1 ,Lon~-~un Incidence
In the long run, supply is assumed to be price elastic; in other
Words, unit costs are expected to be constant.
In this special case,
the price, irrespective of quantity demanded, must rise by essentially
the full increase in the exogenous pollution abatement costs.
Since
the average annualized pollution abatement cost is estimated to amount
to 4.4 percent of value of shipments (see Pollution Abatement Costs,
above), the price is estimated to rise by roughly this amount in the
l,ong run.1
The quantity demanded is determined (in the case of price elastic
supply) by the price elasticity of demand for the product.
Since demand
is assumed to be relatively price inelastic, it follows that the reduc-
tion i~ value of shipments would be small, even in the absence of year-
to-year growth in sales.
Over the last decade, real output has increased.
In the long run, then, quantity demanded will continue to increase though
at a slightly slower rate than if pollution abatement were not required.
1.2
Short-Run lncidence
It is important to consider the effects on the industry of the
transition period When the price is being increased to cover the average
pollution abatement cost.
The relevant questions are (1) how long will.
1. Because considerable investment in pollution abatement has already
heen undertaken, part of this price increase has already taken place.
This consideration will be discussed below. See 2.0 Differential .Costs.
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Cement-7
it take to increase prices by the full cost of pollution abatement,
and (2) which establishments will be unable to absorb the costs during
this interim period?
Since the industry is assumed to be capital intensive,
it follows that supply is price inelastic in the short run.
Demand.
is also price inelastic since it is difficult for builders to change
their requirements on short notice.
The price will, therefore, increase
rapidly as capacity is used up, but few newcomers will be tempted to
build plants until a profit margin is reestablished.
In perio~s of excess
capacity, however, prices will tend to fall as before.
Thus Portland cement
plants will not be likely to pass on. any cost until demand increases
sufficiently to remove much of the excess capacity now existing.
Since demand for cement is increasing, the price increase should be
accommodated within relatively few years.l
Since the process is capital intensive, plants are unlikely to
lay-off many workers unless the decision is taken to cease operations
entirely.
As long as it is possible to assume that the plants are a
homogenous group, this eventuality is not likely to occur.
Exceptions
will be discussed in 2.0 Differential Cost, below.
1. Again, it must be noted that part of the changes have already taken
place, since some plants are already controlled. See 2.0 Differential
~, below.
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Cement~~
2.0
Differential Cost
.Although most plants in the industry
will'have little trouble
.~npas~ing on their average costs of pollution~batement, individual
,p~~n~ ~~ high costs will be in a more difficult situation, in that
their customers may have access to cheaper alternative soUrces of sup-
~ly, n~ely those plants with lower abatement costs.
'!he differential
will therefore have to be absorbed by the equity holders,l who must
decide whether to go out of business or to accept the increased cost
burden.
If a plant does go out of business, there may be additional
.tr~nsition costs which the community as a whole must bear, principally
the cost of prolonged unemployment for the workers concerned.
2.1
Causes of Differential Cost2
'l11ere are three major reasons for differential cost:
size of
the plant, process employed and legislative requirements.
In the case
..of .c.apital intensive industries, the processes employed are of impor-
.tanc.e;
i.e., some plants are obsolescent and require three times as
tJ1anyemployees as new plants for the same output. 3
1. 'l11ose plants whose costs are lower than t\\e average may, of course,
r'rofit by the pollution abatement regulations. :See O1apter 3.
?
. .
For a fuller discussion, see Chapters 3 and Appendix B.
3. 'l11e difference in pollution .abatement costs for wet and dry pro-
cess plants is of less significance in this situation because it appears
to be quite minor (perhaps l.percent of value of shipments per year).
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Cement-9
These obsolescent plants are still in existence because the
industry is capital intensive, and the techniques used are not so
obsolete as to bring the return to capital down to zero.
industry-wide payroll at 30 percent of value added, however, these
With an
'plants must have a very low return on capital.
Statistics are
not available, but it seems reasonable to assume that the oldest plants
have a payroll of 80 to 90 percent of value added.
Consequently
price swings that
are not of major importance to the industry as a
whole may well bite deeply into the obsolescent plant's return to cap-
ital.
The result is that these plants tend to vary their levels of
operation much more than the new plants and. in course of time come to
produce only spasmodically.
Employment tends to vary considerably in
response to changing demand.
2.2
Cost Differentials for Cement Plants
There are no figures available to indicate that the cost of
pollution abatement in relation to capacity is greater for old plants
than for new ones.
Nevertheless, excess capacity exists in the
industry, and it is likely that old plants, as peak producers, operate
at a much lower percent of capacity than do new plants. Moreover,
many new and modernized plants have already installed pollution abate-
ment equipment.
It is assumed here that these considerations will
result in a differential cost of about 3 percentl of value of ship-
ments if obsolescent plants are now forced to aDate, in addition to the
assumed cost of 3 percent to be faced by the bulk of the industry for a
period of years (see 1.2 Short Run Incidence, above). This assumption
1s arbitrary, and is made only to permit the formal analysis below.
-------
.~_......._,- -
. . '''--~~---'---' -
--. _. _.....----~
Cement-iO
Thes~ older plants will therefore face an initial loss of 6
percent 'Whi~h is reduced to 3 percent in the iong run.
For purposes
of discussing whether they will decide to accept this cost, or go out,
elf bUsiness, they are classified as "long-run" and "short-run" 'viable
before investment in pollution controi.
2.2.1
Long-Run.
It was noted above (Industry Economics) that
obsolescent plants require as much as three times the labor per barrel
of output as new plants.
From this fact, it was assumed (2.1 Causes
of Differential Cost) that only 10 to 20 percent of value added reflects
jr6ja return to capital.
This in turn means that the gross return to
capital is only about 10 to 15 percent of value of shipments.
Financial statistics on salvage values are not available on a
4-digtt SIC industry
basis.
Nevertheless, some estimate can be made:
the building and land, for example, can probably be converted to other
uses.
Beyond that, however, the salvage value of the operation (plant,
equi~ent, goodwill) would appear to be negligible.
Each of the obso-
lescent plants, at a very generous est~ate, would lose ~ net return
of only 5 to 10 percent of value of shipments by ceasing operations.1
1. Internal Revenue Service (IRS) data for the comparable 2-digit SIC
industry (Stone, Clay and Glass P'roducts) indicate that the sum of rent,
interest and taxes in 1967 amounted to $678 million, or about 4.9 per-
cent of business receipts of $13,742 million. U.S. Department of the
Treasury, Internal Revenue Service, Statistics of Income. 1967: Business
Income Tax ReturDs (Washington, D.C.: GPO, August 1970), p.9.
This figure (4.9 percent) probably understates the return which could
be made in an alternative use, particularly for the 13 obsolescent plants
with which this study is concerned.
..
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Cemen t-ll
Since this range would be only slightly greater than the 6 per-
cent (declining to 3 percent) of value of shipments assumed to be
incurred through pollution abatement, the incentive for these 13
plants to continue operations would be limited.
It is likely that
,everal plants would be modernized or replaced regardless of
pollution abatement regulations.
A few, however, may close without
replacement.
'lbe total number of employees involved is about 4,000
to 5,000;
perhaps 3,000 could be expected to lose their jobs since
modernization reduces the requirement for labor.
The cost of subsi-
dizing their continued employment by paying the cost of pollution
abatement, might run to several hundred thousand dollars annually.
If this analysis were repeated for the partially modernized
plants, it would be seen that conditions are less extreme, and all
of these could be expected to absorb differential costs that might
arise.
2.2.2
Short-Run.
A different analysis must be employed for
plants that will cease operation in the near future even without
incurring pollution abatement costs.
In such situations, the costs
cannot be looked at in terms of annual costs since these plants will
not remain in operation for the lO-year estimated life of the equip-
ment upon which these costs are calculated.
It was assumed that annualized costs to the obsolescent plants
would be about 6 percent of value of shipments.
In line with Pol-
lution Abatement Costs, above, it is assumed that 2 percent represents
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Ce~ent-~~
~perat1ng and maintenance costs, while 4 percent represents
annua11ze4 investment costs.
This latter figur~ is equivalent
to an initial investment of 20 percent of one year'~ value of ship-
~ents.l
It may be that none of this capital cost can be recovered for
two or three year (until e~cess capacity in the industry vanishes).
Thus
operating and maintenance costs of 2 percent per year would also have
to be borne initially until the industry raised its price.
Table 1
illustrates a possible situation.
Plants with an expected life of
fewer than five years would not have an incentive to continue
operations.
Because this period of time i, ~o long, it
becpmes clear why even long-run viable but oQsolescent plants (i.e.,
before abatement) would have little incentive to continue:
they might
have to operate five years or more without any return on investment at all.
1. t~e investment cost was obtained
This was annualized by dividing by 5
,rip amortized over 10 years).
originally as a dollar cost.
(interest rate of 14 percent,
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Cement-I3
Table Cement-l
SHORT-RUN VIABILITyl
Years of Costs Accumulated Benefi ts4 Accumulated Net
Operation Incurred2 Costs3 Benefits3 Incentive2
1 22 22.00 8 8 -14.00
2 2 23.75 8 15.02 -8.73
3 2 25.29 8 21.18 -4 . 11
4 2 26.64 11 28.60 1.96
1. All figures are expressed as a percent of one year's value of
shipments. .
2. Initial investment cost is assumed to be 20 percent of one year's
value of shipments. Each year I s operating and maintenance charges: tota 1
2 percent of the year's value of shipments.
3.
Present value, assuming a discount rate of 14 percent.
4. Benefits include 8 percent of value of shipments (i.e., the return
above opportunity costs) each year and a price increase of 3 percent
after a period of three years.
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Cemetlt-l4
2.3
Summary
Assuming costs of pollution abate~ent fall within the range
." .
of figures discussed in this section~ it i~ likely that the 13
f~rms not presently abating will cease operations if compliance with
pollution abatement regulations beco~es necessary.
While most" if not
all, will be modernized or replaced, the loss in jobs might be as much
as 3,000 employees.
This would occur at some f1.1ture dat:1e in any event,
and would require large subsidies if unemployment were forestalled.
Most of the remaining plants have already at least partially
, "
modernized and, therefore, have greater expectations for the future.
Toese plants will not alter toeir employment or output in response to
pollution abatement requirements.
3.0
Sensitivity Analysis
As a rough judge of the acceptability of these estimates, a
sensitivity analysis can be performed by varying each number in turn
to determine its effect on the overall conclusions.
3.1
Stability of Price Considerations
There is little reason to doubt the accuracy of the estimated
average annualized pollution abatement cost of 4.4 percent of value
of shipments.
(See Pollution Abatement Costs, above.)
For the pur-
poses of a sensitivity analysis, however, an extreme case is here
postulated and the assumption made that annualized pollution abatement
costs for cement are tripled to 13.2 percent of value of shipments.
-------
Cement-15
analysis, however,an extreme case is here postulated and the assumption
~~de that annualized pollution abate~nt costs for cement costs are
tripled to 13.2 percent of value of shipments.
In the lon~ run. the price will rise by essentially the
full annualized cost of pollution abatement -- in this estimate, 13.2
percent.
In the short run, however, supply is price inelastic, and
the p"C'ice may not rise fully for several years.
The inelasticity
of demand suggests that this time frame will be limited once present
excess capacity is eliminated.
Since 2ross return to capital avera2es about 45 percent of
shipments for the industry as a whole, it is not likely that even a
10 to 15 percent cost in terms of value of shipments would result
in failures of "average" firms.
This is particularly the case since
the losses would occur for a few years only.
It is clear~ however. that the obsolescent plants considered
would close immediately.
Those still requiring extensive modirications
would also have little incentive to continue.
3.2
Differential Pollution Abatement Costs
The closure rate is usually more sensitive to the differential
than the average cost (expressed as a parcentage of value of shipments).
This is less true for capital intensive than labor intensive industries
because the former ~ay experience greater difficulty in raising prices
when they have excess capacity.
-------
_.~..-.:... ....---..-.-'..-----"- .....::.:.~:. -'--
Cement;.. 16
It: is sufficient to consider only the most obsolescent group
of plants, i.e., those with the greatest cost 6f labor and supplies
~er-uni~ of output.
Other groups of ptanis are likely to
absorb; differential costs because they cannot afford to cease operations.
In the example cOQSidered above, all of the obsolescent plants would
ClCee even with relatively minor differential costs (see 2.0 Differential
Costs.)
3~3
The Effect of Misinformation
As outlined in Chapter 4, it is possible that financial
ihstltutions will not recognize- that pollution abatement requirements
in a~'industry will be fol1~~ed by price increases.
In effect, it
~ight be assumed that the entire cost of pollution abatement will be
borne by the firms themselves.
This problem is not of great significance in a capital in-
tensi~e industry if excess capacity exists.
The reason is that prices
w'U 1 not increase for so:ne years in any event, and the discounted value
of future price increases, which financial institutions might ignore,
18' low.
In a period of increasing prices (i.e., when there is no excess
capacity), it seems likely that
the plant could persuade the
bank that price increases could be' expected 'to continue.
Even in-this
situation, few potentially viable firms would be turned down.
-------
Cement-17
3.4
Uncertainty
The above discussion has concerned the number of
firms which would c10se rather than pay specific levels of pol-
lution abatem2nt costs.
A banker, however, must determine which
firm$ close. As pointed out in Chapter 4, this is particularly difficult
When either price elasticity or cross-elasticity of demand is high.
Neither
appears to be the case for the hydraulic cement industry.
The possi-
bility of fluctuating prices due to supply price elasticity in the the
short run may create some uncertainty, but the arguments of 3.3 The
Effect of Misinformation can be expected to hold.
3.5
Smnmary
For the Portland cement industry, few figures appear to
require more than rough estimation.
It is, however, of crucial im-
portance to separate out the most obsolete plants from the rest and to
determine with a fair degree of accuracy, the relative costs of labor
and supplies per unit of ~tput.
Any impact on employment will come
from the failure or replacement of these plants.
-------
CASE STUDY 1/3:
PRIMARY COPPER SMELTERS
Objective
This section is a methodological exercise to illustrate the
application of predictive crite~ia to a resource iht~nsive industry.
The data used are again, in many cases~ outdated or incomplete;
therefore the quantitative results are for illustrative purposes
only.
Context
The primary copper industry has been selected as an example of
a resource intensive industry because the cost of materia1s~ mainly
copper, at $935 million, is 79 percent of value of shipments at
$1 , 184 million. 1
The industry is clearly concerned with processing
raw materials.
The smelting process itself is relatively capital
intensive since payroll (80.6 million) is only 30.7 percent of value
added ($262.6 million),2 considerably below the 47 percent figure for
all manufacturing.
Consequently, the short run repercussions in the
. industry are similar to those for capital intensive industries.
Industry Economics
Of copper produced a large proportion is used for electrical
transmission and equipment, substantial amounts in automobiles and
1. U.S. Department.of'Commerce, Bureau 'of the Census, 1967 U.s.
Census of Manufacturing: Industry Statistics, Vol. II (Washington,
D.C.: GPO, 1970), Table 4, "General Statistics, by Employment Size
of Establishment: 1967" (SIC 3331).
2.
Ibid.
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Copper-2
plumbing.
Substitution of aluminum is possible in the first two
instances, depending on price, and is increasing in automobile manu-
facture.
For some types of plumbing, plastics are substitutes.
World capacity.has been increasing faster than world demand, while
military requirements for copper are declining.
There may therefore
be excess capacity by the mid-1970's, with consequent price decreases
in contrast to the rising prices of the 1960's.1
This situation,
of course, is not related to environmental costs.
Since copper ore is reduced in volume considerably in the
refining process, there is a tendency for smelters to locate close
to major ore deposits.
However, the price of copper is high com-
pared to its transportation costs, and the local markets tend, there-
fore, to cover large areas.
International trade is important as about
15 percent of copper ore is imported, while almost as much is ex-
ported after refining.2
This consideration limits the ability of
producers to pass costs on to their customers or back to the mine-
owners, since competitors in other countries, except possibly Canada,
do not necessarily face similar environmental costs.3
1. Average weighted prices of domestic copper deliveries increased
from about $.31/lb. in 1963 to $.48/1b. in 1969; for foreign copper,
the increase was greater: from $.31/1b. to $.63/1b. U.S., Department
of the Interior, Bureau of Mines, Bureau of Mines Minerals Yearbook
(1967 and 1969) (Washington, D.C.: GPO, 1967, 1969). Copper--
tables 29 (1967) and 32 (1969).
2. In 1969, U.S. exports of copper aggregated to $315 million while
imports amounted to $414 million. Ibid.
3. Exports from the U.S. are principally to Canada and Mexico, while
imports are principally from Peru, Chile and Canada. When only imports
of refined copper are considered, in 1969 Canada exported 60 percent
of the total, and Chile 15 percent. Ibid.
-------
-~
Copper...:}
A good 85 percent of eopper mined in the U.S. comes from open
pits~ and this mining, by contrast with smelting, is a labor intensive
industry.
As outlined in Case Study #1 above, a labor intensive
industry is more likely to reduce output and employment than to re-
duce prices significantly.
This situation limits the ability of
smelters to recover part of the costs of pollution abatement by
paying less for ore.
Over the- long run, price differentials according
to the sulfur content of the ore may induce extraction of otes with
low abatement costs.
Pollution Abatement Costs
It should first be reiterated that this analysis is concerned
only with air pollution abatement costs and does not include all
costs of environmental protection.
The major air pollution problem
for copper smelters comes from sulfur oxide emissions; the extent of
the problem and the cost of controlling it depend both upon techniques
used in the smelting process and upon the percentage of sulfur in the
copper ox:e.
The relevant techniques are roasting (a preliminary process
used by five very old plants as well as some of the most recent),
conversion and reverberation.
For the roasting process, which gives
off gases rich in sulfur compounds, the appropriate abatement technique
in most cases is to install a sulfuric acid recovery plant.
four such plants are already in operation at a profit.l
Indeed
For
1. Report of the Administrator of the Environmental Protection Agency,
The Economics of Clean Air (Washingt'on, D.C.: GPO, 1971), p. 4-112.
-------
Copper-4
converters, whose emissions are generally less rich in sulfur
compounds, the choice is between an acid recovery plant or a lime
scrubber; if the price for sulfuric acid falls substantially many
plants may decide to use the latter.
At the reverberator stage,
emissions contain so little sulfur that lime scrubbers are the
obvious solution.
The total investment cost of abatement estimated at $87
million with an annual cost by fiscal year 1976 of $42 mi11ion.1
(These costs are maximal since they do not reflect any recovery from
2
the sale of sulfuric acid. )
The annualized cost for the typical
establishment would be 5.3 percent of the value of shipments.3
Of
this about 1.6 percent represents the annualized investment cost,
and the remaining 3.7 percent represents annual operating and
maintenance costs.
1. Report of the Administrator of the Environmental Protection Agency,
The Economics of Clean Air (Washington, D.C.: GPO, 1971), p. 4-103.
2. If only lime scrubbers are used to remove the sulfur the total
investment cost would be $63.6 million with an annual cost by fiscal
1976 of $29.6 million. (This figure is obtained by comparing average
firm costs for sulfuric recovery plants and the average costs when
lime scrubbers are used exclusively.) In this case, there is no
recovery of saleable products. The average annualized cost for an
establishment would be 3.7 percent of the value of shipments. (This
figure is obtained by dividing the annual costs of $29.6 million by
the value of shipments of $800 million.) Ibid., p. 4-112, 4-113.
3.
~.J p. 4-20.
-------
.
Copper-S
Economic Analvsis
1.0' Price Changes
Since the primary copper industry is resource intensive, it
is assumed that supply increases only in response to price increases
in the long run (see Chapter 2).
For the short run, it is necessary
to look at the particular characteristics of the industry.
Since
the actual smelting process is capital intensive, industry supply
is relatively price inelastic in the short run; that is, the 'quantity
sold will tend to vary little with price fluctuations.l
The demand for copper appears to be relatively price inelastic.
That is, the quantity demanded will not vary markedly in response to
changes in price.2
This conclusion is reinforced by realization
that aluminum, the major competitor in copper markets, will be
faced with somewhat higher costs for air pollution abatement than
wi 11 copper. 3
Nor is copper often a major cost component of the
service desired or of the customer's budget.
Discretionary purchases
of copper are limited.
In the short run then, demand for copper is
relatively price inelastic, while in the long run, this is less so.
1. But note that the conclusion is limited to some extent by the
more labor intensive influence of the mines themselves.
\....
2. It seems more likely that changes in autonomous demand have
greater influence on price fluctuations than the moderating influence
of changing the quantity supplied.
3. Aluminum cost of abatement is estimated at 6.9 percent of value
of shipments in comparison with copp'er's 5.3 percent. .!k!E.." p 4-20.
-------
Copper-6
1.1
Lon~-Run Incidence
In the long run, supply increases only as p~ice increases.
Thus, with an addition of air pollution abatement costs, estimated
here at 5.3 percent of value of shipments, the price will tend to
increase by less than this amount.
The quantity demanded is determined by the intersection of
the demand and supply curves.
The position of the new intersection
depends on the relative elasticities of the two curves.
The fact
that demand is relatively price inelastic (especially considering that
substitutes will bear similar cost burdens), and that supply of ore
does not appear to be on the extreme of inelasticity, suggest that
retrenchment will be minor.
A considerable portion of this burden
will be carried by customers, but part may be carried by both mine
owners and owners of the smelters.
The cost to the latter will come
about primarily in the form of market encroachments by international
competition which does not have the same environmental costs.
It seems likely that the distribution of costs in the long
run may be as much as a 3 percent price increase, 1.5 percent reduc-
tion in prices of the ore and perhaps 1 percent loss to the smelter
owners in an attempt to meet competition.
The figures should, however,
be treated with considerable caution.
If this were the case, some
reduction in employment in domestic ore production might be expected,
but the extent would be very small.
No employment effect would. be
noted at the smelters since the 1 percent figure is small compared
-------
Copper~7
to the 15.4 percent of value of shipments representing gross return
to capita1.l
1.2
Short-Run Incidence
It is important to consider the effects on the industry of
the transition period during which the price is being increased to
aid in covering the average pollution abatement cost.
The relevant
questions are (1) how long will it take for price increases to take
effect, and (2) which establishments will be unable to absorb the
costs during this interim period.
Supply is relatively price inelastic in the short run.
Demand,
however, is also price inelastic, since it is difficult for buyers
to find cheaper substitutes, especially on short notice.
The price
will therefore increase rapidly as capacity is used up, yet few
newcomers will be tempted to build plants.
In periods of excess capacity, however, prices will tend to
fall as before.
This is a particular problem for the primary copper
industry since demand is expected to recede substantially from the
peaks achieved in the late 1960's.
Thus price increases to cover
the costs of pollution abatement may not occur until the late 1970's
unless substantial numbers of plants are closed down in the interim.
1. Value added less payroll was $182 million in 1967. This is 15.4
percent of the year's value of shipments of $1104 million. u. S.,
Department of Commerce, Bureau of the Census, 1967 U. S. Census of
Manufacturin~: Industry Statistics, Vol. II (Washington, D. C.:
Government Printing Office, 1970), Table 4, "General Statistics, by
Employment Size of Establis.l:un.ent: . 1967" (SIC 3331).
-------
Copper-8
The most likely result would appear to be closure of a small
number of obsolescent plants, (see 2.2.2 Short-Run Plants, below)
accompanied by a reduction in production by the rest.
This in turn
would result in lower prices for the ore, along with decreased
employment and production.
2.0
Differential Cost
Most smelters within the industry will be able to absorb or
pass on their costs of pollution abatement (assuming the figures used
are appropriate estimates), individual plants with high costs will be
in a more difficult situation, in that their customers will probably
have access to cheaper alternative sources of supply, namely those
plants with lower abatement costs.
The differential will therefore
have to be absorbed by the equity holders, who must decide whether
to go out of business or to accept the increased cost burden.
If a plant does go out of business, there may be additional
transitional costs which the community as a whole must bear, prin-
cipally the cost of prolonged unemployment for the workers concerned.
2.1
Causes of Differential Costl
There are three major reasons for differential cost:
plant
size, process employed, and legislative requirements.
The most
important source of difference is different processes employed, as
several "generations" of copper smelters exist.
1.
For a fuller discussion, see Chapter 3 and Appendix B.
-------
"-- ._........106;...~._.._.
Copper-9
The oldest type utilizes roasters before the ore is passed
through the converters and reverberators.
These obsolescent plants
are still in existence because the production method is capital in-
tensive, and the techniques used are not so obsolete as to bring the
return to capital down to zero.
Statistics are not available, but
if the average gross return on capital is 15.4 percent of value of
shipments, the obsolescent plants may obtain a return much lower
than this.
Although in this case the oldest plants are unlikely to
have greater costs of pollution abatement in terms of sales than the
average, they may have difficulty in absorbing costs for several years.
2.2
Cost Differentials for Smelters
There are no figures available to indicate that the cost of
pollution abatement in relation to capacity is greater for obsolescent
plants than for modern ones.
Nevertheless, excess capacity will exist
in the industry by the mid-1970's, and it is likely that the older
plants will tend to be used only for peak production, and therefore
operate at a much lower percent of capacity than do new plants.
On
the other hand, since tbe oldest plants use roasters, they have the
best opportunity to reduce abatement costs through the recovery of
sulfuric acid.
Obsolescent plants will therefore be assumed to face the in-
dustry average costs:
5.3 percent of value of shipments for several
years" dropping to I percent.
For purposes of discussing whether,
these plants decide to accept this cost, or go out of business, they
are classified as "long-run" or "short-run" viable before investment
in pollution abatement.
-------
Copper-lO
2.2.1
Long-Run Plants.
In some cases obsolescent plants can
coexist for many years with newer versions.
In this case the impending
excess capacity may well result in a number of failures among the
most obsolescent plants:
this contingency is outside the terms of this,
which considers only the effect of pollution abatement costs, other
things being equal.
While it is established that plants within the primary copper
industry vary in productivity, information is not available concerning
the relationship of payroll to value added.
Nor can a precise measure
of opportunity costs be calculated since financial statistics are not
presently available on a 4-digit SIC basis.
Nevertheless, some
estimate can be made based on IRS data for the comparable 2-digit
1
SIC industry.
In order to overstate the magnitude of unemployment
it is assumed here that a plant could cease operations, and the cash
obtained as the salvage value of the plant could be reinvested to
return an amount equal to 10 percent of value of shipments.
It seems likely that even the obsolescent plants can earn more
than this sum through producing copper:
moreover the mines they
1. IRS data for the comparable 2-digit SIC industry (Primary Metal
Industries) indicate that the sum of rent, interest, and taxes in
1967 amounted to $1,768 million, or about 4.4 percent of business
receipts of $40,154 million. u. S.,Department of the Treasury,
Internal Revenue Service, Statistics of Income, 1967: Business Income
Tax Returns (Washington, D. C.: GPO, August, 1970), p. 9
This figure (4.4 percent) probably understates the return which
could be made in an alternative use because property, at least, is
often mortgaged for considerably less than its market value. This
would be particularly true of the obsolete, failing establishments
with which this study is concerned. To be on the conservative side,
then, the figure has been increased to about 10 percent.
;;'
-------
.~___"h._- ..~ ,-.-----.........'
Copper-ll
purChase from have probably been worked for some period of years,
with few alternative opportunities for sales.
If the cost of pollu-
tion abatement cannot be borne by the producers themselves, the
mines will in all probability be forced to renegotiate their contracts.
2.2.2
Short-Run Plants.
A different analysis must be employed
for plants which are likely to cease operation in the near future
even without incurring pollution abatement costs.
In such situations
the costs cannot be looked at ~n terms of annualized costs, since
these plants will not remain in operation for the lO-year estimated
life of the equipment upon which these costs are calculated.
It was assumed that annualized costs for the obsolescent
plants would be 5.3 percent of value of shipments.
In line with
Pollution Abatement Costs, above, it is assumed here that 3.7 percent
represents operating and maintenance costs, while 1~6 percent repre-
sents annualized investment costs.
This latter figure is equivalent
1
to an initial investment of 8 percent of one year's value of shipments.
Since most of the costs of pollution abatement are associated
with operating and maintenance, it is clear that even short-run viable
firms would probably be able to pay for pollution abatement.
It
might be decided, however, that replacement of a plant would be pre-
ferable to installing the equipment:
this decision, regardless of,the
public relations surrounding it, would have little to do with pol1u-
tion abatement.
1. The investm~nt cost was obtained originally as a dollar cost.
This was annualized by dividing by 5 (interest rate of 14 percent,
and amortized over 10 years).
-------
Copper-12
3.0
Sensitivity Analysis
As a rough judge of the acceptability of various estimates,
a sensitivity analysis can be performed by varying each figure in
turn to determine the effect on the overall conclusions.
3.1
AveraRe Pollution Abatement Costs
The costs used in this section may underestimate total costs.
One source indicates much higher costs:
A study made of the copper industry by an in-
dependent engineering firm estimated that the
capital investment required to implement con-
trols at 12 western smelters that would allow
compliance with Federal ambient air quality
standards would be approximately $600 million.
This includes the capital cost of new plants
necessary to maintain industrywide levels of
production, assuming some operations are cur-
tailed to meet the most stringent and universal
emission standards.l
Of the $600 million, about half the capital cost will be for
new smelters.2
This cost is clearly irrelevant to the overall con-
elusions of the present study, since the new smelters will not be
built unless they are profitable.
Nevertheless, since this study is
dealing in maximal costs, it is assumed here that this is the ap-
propriate figure to indicate initial investment, with annualized
1. u. S.,Department of the Interior, Bureau of Mines, Control of
Sulfur Oxide Emissions in Copper. Lead. and Zinc SmeltinR (Washington,
D. C.: GPO, 1971), p. 3.
2.
Ibid., p. 50.
-------
Coppet;~13
cos~s of $200 million. An0U41ized cost of pollution abatement there-
fore is assumed to represent 10.5 p~rcent of the industry value of
shipptents.l
In the long run, prices ~ill increas~ by less than the full
10.5 percent.
As indicated in 1.1
Long-Run Incidence, p. 6, demand
is relatively price inelastic, so that a considerable proportion of
this burden will be carried by customers.
However some price
resistance may cause the mine owners to lose sales, and therefore
absorb some of the cost, and the smelters may lose some business to
foreign producers.2
It is possible, however, that the necessity of absorbing up to
10.5 percent of value of shipments for a period of several years would
force some of the obsolete producers into bankruptcy.
be avoided if the mine owners had limi,ted alternative markets.
This would
3.2
Differential Pollution Abatement Costs
There is no information to indicate that differential poIlu-
tion abatement costs exist.
For a resource intensive industry in
which such costs occur, the appropriate sections in the other two
case studies in this chapter provide models.
1. For the entire industry, value of shipments was $1,895 million.
u. S.,Department of ~he Interior, aureau of Mines, Control of Sulfur
Oxide Emissions in Cop~er. Lead. and Zinc Smelting (Washington, D. C.:
GPO, 1971), Table 1, "Primary Nonferrous Smelter Operations," p. 5.
2. Evidently these last possibilities are considered to.be minor by
the industry, which expects to re~ain its position by building new
smelterS if necessary.
-------
Copper-l4
3.3
The Effect of Misinformation
As outlined in Chapter 4, it is possible that financial in-
stitutions will not recognize that pollution abatement requirements
in an industry will be followed by price increases.
In effect, it
might be assumed that the entire costs of pollution abatement will
have to be borne by the plants themselves.
This problem is not of great significance in a resource in-
tensive industry if excess capacity exists, since prices would not
increase for some years in any event.
On the other hand, in a period
of increasing prices (i.e., when there is no excess capacity), it
seems likely that the plant could persuade a bank that price increases
could be expected to continue.
In this situation, few potentially
viable plants would be turned down.
In addition, most resource in-
tensive plants are closely associated with their suppliers or customers
and can raise funds internally.
3.4
Uncertainty
The above discussion has concerned the number of establishments
which would fail rather than pay specific levels of pollution abate-
ment costs.
A banker, however, must determine which establishments
are likely to fail.
As pointed out in Chapter 4, this is particularly
difficult when either elasticity or cross-elasticity of demand is
high.
Neither appears to be the case for the primary copper industry.
The possibility of fluctuating prices due to supply price elasticity
in the short run may create some uncertainty, but the arguments of
The Effect of Misinformation can be expected to hold.
-------
Copper-iS
3.5
Summary
For the primary copper industry, it is evident that pollution
abatement regulations will not .result insignificant changes in out-
put of employment.
The figures used above are only rough estimates,
but it has been indicated that the conclusiorts remain the same even
when these estimates are doubled or tripled.
It does not appear
likely that there will be any closures as a result of pollution
abatement though management may close down obsolescent plants, using
the environment as a scapegoat.
-------
CHAPTER
6
PROGRAMS:
LEGAL REQUIREMENTS AND POLICY ALTERNATIVES
Summary
In the overwhelming majority of regulatory situations, policy
decisions are made for political reasons and not on the basis of Con-
stitutional requirements.
Neither the Federal Government nor any
state government has a legal obligation to provide assistance to plants
or individuals adversely affected by the costs of pollution abatement
controls .
However, assuming that a decision is made to provide assistance
in order to prevent unemployment, several alternative policies might be
adopted according to the circumstances of the case.
The most effective courses of action with regard to economically
non-viable plants would be to provide either:
1.
No direct assistance to the plant, while instituting training
and relocation programs for the benefit of displaced workers, or
2.
Subsidies to cover the costs of abatement in whole or in
part, or
3.
Variances (temporary or permanent).which amount to an indirect
form of subsidy.
In the case of potentially viable plants, only two forms of as-
sistance would seem to be appropriate:
1.
Loans (direct or guaranteed).
The Small Business Administration
has both the facilities and experience to handle loans in this connection,
and it would seem unnecessary for the Environmental Protection Agency to
set up a separate pro8ram for the purpose.
-------
6-2
2.
Variances.
If the variance is granted on a temporary basis,
charges might be made for the privilege of continuing to pollute.
This
money could be placed in an escrow fund until a sum large enough to con-
vince financial institutions of the advisability of p~oviding a loan, and
to constitute the necessary downpayment for such a loan, has accumulated.
A brief outline is provided of a number of existing federal programs
that might be regarded as precedents for adopting one or other of the
courses of action listed above.
-------
6-3
Government Regulation -- Legal Implications
Before discussing in greater detail the different assistance
strategies that the government might pursue, it is ~portant to under-
stand the ~plications of governmental regulation.
In particular, it
is important to find out if the government has any obligation to pro-
vide compensation or assistauce to plants or others affected by the cost
of pollution abatement.
Generally, when the Federal Government or a state enacts legis-
1ation that is essentially regulatory in nature, no provision needs to
be made to compensate the entity being regulated for the cost of complying
with the regulation or standards.
There appears to be no legal require-
ment to pay this cost even if a firm finds it ~possib1e to meet the
standards and is forced out of business.
Any government is considered to have as an element in its
sovereignty the authority, commonly referred to as police power, to make
and establish laws for the welfare of its citizens.
As long as legis-
lation is designed to protect the health, safety, welfare, or morals of
the community, the courts seem willing to permit its enforcement as a
proper exercise of police power.
However, the exercise of police powers by the government is limited
by the requirements of the Fourteenth Amendment to the United States
Constitution which requires the government to pay for private property
1
taken for public use.
The courts have interpreted "taking of property"
1. Although the Fourteenth Amendment does not state this in so many
words, the courts have given this interpretation to. the "due process"
clause of the amendment.
-------
6-4
very strictl~ so that, unless land is actually expropriated by the
govermnent,l
no compensation is paid.
The fact that a person's
business is so strictly regulated that his inc~e is decreased2
or that he is prohibited from using his_yrQP~rty for its most
economically beneficial purp.ose 3 does not constitute a taking.
'!he states may also use their zoning laws in the same way to prohibit
4
certain uses of the property. . Exercise of controls such as these
are considered to be a part of the state's legitimate police powers
as long as there is a valid reason for the regulation.
However, a
state cannot prohibit the sole economic use of a person's property,
since this would be regarded as a virtual taking of the property.
The burden of proving the invalidity of a regulation rests on the
person claiming that it is invalid.
The Federal Government is also restricted in its expropria-
tion of private property by the Fifth Amendment to the United States
Constitution.
The pertinent part of the amendment states that no
person shall "be deprived of life, liberty, or property, without due
1. This is usually done through the exercise of the power of eminent
domain, th,e right of the government to take possession of property for
the public' good by compensating the owner for its value. Eminent do-
main is usually exercised through a compulsory sale to the government
of a person's property after a lengthy procedural process.
2.
Williamson v. Lee Optical, 348 U.S. 483 (1955).
3. Goldblatt v. Hempstead, 369 U.S. 590 (1962) and Blancett v.
Montgomery, 398 S. W. 2d. 878 (Ky., 1966).
4. An authority in land develoP,ment law has stated that under zoning
laws a state could probably eliminate billboards from interstate or
state roads without the necessity to pay the ~illboard owners. George
Lefcoe, Land Development Law (Cinc!nnat1: Bobbs-Merrill,Inc., 1966),
p. 1403. .
-------
6-5
process of law, nor shall private property be taken for public use,
without just compensation" (emphasis a.dded).
'lbe courts have inter-
preted this in much the same way as the Fourteenth Amendment prohibi-
tion which applies to both the states and the Federal Government.
There must be an actual expropriation of property, and not merely a
regulation for its use, for compensation to be required.
Because any laws passed by Congress must be specifically
grounded upon some grant of power given to it in the United States
Constitution, the police powers of the Federal Government are not so
extensive as those of the state governments.
However, the grants of
authority given to Congress have been very broadly construed by the
Supreme Court.
For example, the Commerce Clause, which gives Congress
the right to regulate interstate commerce,l is so broadly interpreted
that the regulatory power it conveys to Congress is almost limitless.
Under this provision, Congress has passed such diverse legislation as
health and safety acts, minimum wage acts, and far-reaching labor
legislation.
So long as legislation such as this only reduces the
value of private property and does not actually expropriate it, then
2
compensation is not required.
Even in cases where the courts have ruled that there has
been a taking of property, they have never required the state or
Federal Government to pay certain costs, such as relocation costs
1. 'lbe Commerce Clause is found in the United States Constitution,
Article I, Section 8, Clause 3.
2.
Bowles v. Willingham, 321 U.S. 503 (1943).
-------
....L.
6.6
or loss of good will that are incident to the expropriation.
Re-
location costs have been held by the courts as analagous to costs
that result from the te~ination of a lease.
Since the occupant,
if he ~ere a lessor, would have to relocate when his lease expired,
the courts say that he is put in no worse position if his property
is taken by eminent domain.
His right to use the property has ended,
and there is accordingly no obligation to pay relocation or other
costs involved in re-establishing a business.
The courts also re-
fuse to grant compensation for business losses or losses in goodwill
because these are considered too speculative. to be adequately deter-
mined.
The theory is that the government is obligated to pay the
owner the value of the property, but not the special value that the
property may have for its present owner, which would include such
elements as relocation costs and goodwill.
It is important to note that the decision to grant compensa-
tion in the overwhelming majority of regulatory situations is made
on the basis of political rather than legal considerations.
The
government is rarely required to pay for the consequences.
In pollu-
tion control, this is particularly true since no governmental invasion
of property can be shown.
In fact, if any property invasion results,
it is a result of the polluter's conduct.
If viewed in this light,
pollution control laws can be vie~ed as laws to restrict the invasion
of property by polluters, instead of an invasion of a polluter's pro-
perty rights.
Any aid, whether in the fo~ of subsidy or other assis-
tance to a fi~, would be given strictly for political and policy
reasons rather than any Constitutional compensation requirements.
- --...-~~ ~ - --.
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6-7
Program Alternatives
Any new government regulation, such as an emission or effluent
standard, results in a sudden change of costs to the regulated party.
If this change is an increase, the increased costs may be paid by the
regulated party (and ultimately these costs are usually passed along
to the consumer) or by the government.
The proportion in which these
costs are borne is essentially a public interest question which is
usually decided politically.
, i
In this study it has been assumed that the brunt of the costs
will be borne by the private sector or the taxpayer, although those
damaged by pollution may still be forced to bear some costs, if stan-
dards are not enforced or effective.
While publicity and political interest have generally focused
on the need to force the private sector (industry) to clean up pollu-
tion, in practice the public sector has borne a large part of the costs
through rapid amortization of equipment costs, tax credits, and grants
to municipalities for sewage treatment plants.
Consequently, the public
and private sectors have thus far shared the abatement costs nearly
'equally.
In spite of this division, it is estimated that in 1970-75 the
private sector will have to spend 35.6 billion dollars for air and water
pollution abatement equipment.
1. The Council on Environmental Quality, Second Annual Report, Environ-
mental Quality (Washington, D.C.: GPO, August 1971) p.110
2.
Ibid.
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6-8
There are four basic ways in which the government can respond to
the needs of firms adversely affected by the costs of pollution abatement.
1.
No Assistance.
While no direct assistance would be provided for
the plant, frictional problems such as unemployment might be alleviated.
Subsidies.
Subsidies might be provided to defray a portion of,
2.
or even the entire, capital costs of abatement equipment.
3.
Loans.
Loans to cover the costs could be guaranteed by, or
received directly from, the government.
4.
Variances.
Finally, the government might grant a variance or
exemption from enforcement of pollution control laws.
Variances can be
either short- or long-term;
they might even be permanent although this
is unlikely because it would result in the pollution continuing indefi-
nitely.
These strategies are not, of course, mutually exclusive;
a pro-
gram of government assistance could contain elements of two or more.
Selectivity
Within each strategy, there are many forms that a particular pro~
gram might take.
For example, subsidies might be given to all firms that
incur pollution abatement costs, or only to firms whose costs rise above
some determined level.
Simi1ar.ly, a strategy might be focused upon pro-
viding assistance uniformly to all areas and individuals.
Because of the
innumerable ways that a program- could be selectively applied, no attempt
if, mad~ to discuss each strauegy in terms of selective application.
-------
6-9
Non-Viable Plants
The closure of a plant may create serious difficulties in areas
of the country already
suffering from high unemployment.
There are
various courses of action that might be adopted to minimise such pro-
b1ems, in the case of non-viable plants.
The effectiveness of each
course will depend upon the length of time the plant can be kept in
operation, compared with the cost of implementation.
No Assistance
Economically, this strategy has the advantages of forcing all
plants to recognize pollution abatement as one of their costs of doing
business.
It would mean that plants and their consumers would pay the
full pollution control costs while those employees who were laid off
would bear the full adjustment costs of moving to other jobs.
The
government has used a similar "no assistance" strategy in its minimum
wage acts, although it should be noted that in these cases one reason
given for withholding assistance was that firms complying with the law
did. not incur capital costs, whereas capital costs are the most signi-
ficant part of abatement costs.
In any event, the magnitude of the fric-
tional problems resulting from plant closures will be the most important
factor in determining whether or not some assistance should be provided.
If there are few closures, or if workers can readily be transferred to
other jobs, there will probably be no need to assist either workers or
plants.
-------
6-10
,rric~ional Problem Assistance.
When a plant closes as a result of
government policy, there are precedent~ for assisting workers and the com-
mtlnity affected by the closure.
The Trade Adju$tment Assistance Program
and the Community Economic Adjustment Program provide two examples.
The Trade Adjustment Assistance Program was established under the
Trade Expansion Act of 1962.
The program was set up to help those indus-
tries, firms and workers ~o would be injured as a result of concessions
made in a trade agreement which alloWed competitive products to betm-
ported in large quantities.
It includes provisions for direct loans,
job training, readjustment and relocation allowances.
It should be noted,
however, that training and relocation programs have not, in the past,
proved very successful.
The Community Economic Adjustment Program was established about
ten years ago by a directive from the Secretary of Defense, and provides
assistance to communities which suffered severe economic effects from
personnel cuts, base closings, the termination of major contracts, or
other major Defense Department actions.
Subsidies
A direct subsidy may cover all the initial cost of control or
some part of it.
Most federal programs utilizing this strategy make no
attempt to distinguish between plants that do not need the subsidy from
those who could not pr0vide the funds th~mselves, although this distinction
could be made.
Similarly, most government sUDsidy programs make no
attempt to distinguish between non~viable and potentially viable plants.
-------
6-11
A full cost subsidy program would be stmple to administer but ex-
pensive.
The major advantage would be the elimination of adjustment
costs in terms of unemployment. Plants would have no new costs associated
with the controls, and therefore no costs to pass on to consumers.
The major difficulty with full cost subsidies is that the taxpayer
bears the costs of abatement rather than the consumer (or supplier or
equity holder).
Consequently, pollution control costs are not recognized
in product prices and the result is an inefficient allocation of resources.
Misallocation could be reduced by applying full cost subsidies selectively.
Alternatively, a subsidy could defray only those abgtement costs
which the plant could not bear.
Cost sharing subsidies of this type would
vary according to the needs of particular plants.
Just as full cost subsidies could be selectively applied to increase
economic efficiency or to assist only plants with substantial pollution
control costs, so also could cost sharing subsidies.
For example, cost
sharing might be applied only to plants with substantially higher abatement
costs than other plants in the industry, provided that the plant is located
in a depressed area.
This would protect employment in areas where unemploy-
ment is a significant problem.
Basically, a cost sharing program helps plants that are most ad-
versely affected by abatement costs.
This results in a leveling effect;
plants adversely affected by abatement costs receive a subsidy, while those
less severely affected do not.
Consequently, the actual cost to plants in
an industry tends to be the same.
This equalizatiori of costs also tends
to keep the competitive position of all firms within an industry the same
as it was before pollution abatement.
-------
6-12
.The Marittme Administration has two cost sharing subsidy programs:
the Construction-Differential Subsidy and tqe Operating-Differential Sub-
. . .
sidy, which were autho:dzed under the Merchant Marine Act of 1936.
Nei ther
of these programs allows the Maritime Administration to increase their aid
or give technical assistance in case of threatened bankruptcy in order to
protect the government investment.
This situation points out the need to
provide flexibility in legislation so that program administrators can make
progr~s work as intended.
Variances
Basically, a variance 18 a statement by a pollution control agency
that it will not enforce a pollution control standard against a particular
pollu ter.
By the terms of the variance, the polluter is permitted to ope-
rate in violation of the applicable standard.
This right to violate the standard is rarely indefinite in duration,
although in some cases it might be.
Generally, the variance requires com-
pliance within a specified length of time, which means that sooner or later
the firm must finance pollution abatement costs.
Unless the firm's economic
position is drastically changed, it is unlikely that it will be able to pay
costs more readily in the future than it can a~ the present time.
Therefore,
either the variance must be indefi,nite or some other course of action must
be adopted.
The major disadvantage of a variance is that the costs of damages
continue to be borne by those being polluted.
Furthermore, because the
manufacturer is not forced to include the costs of control in his production
costs, prices for products produced by polluters are artificially low.
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6-13
Consequently, variances are granted only when the pollution con-
trol agency determines that the public .interest in clean air or water
is outweighed by these disadvantages.
Determinations are usually made
to avert closure or serious unemployment.
It is possible that a variance
might be the most appropriate solution for non-viable plants, particularly
for small plants in rural areas where closure might remove the economic
basis of a whole community; in such instances a comparatively insigni-
ficant amount of pollution might be the lesser of two evils.
Strategies for Potentially Viable Plants
Government Loans
Government loans are the obvious course of action for assisting
potentially viable plants that are unable to obtain commercial financing.
The government could either make loans directly to these plants or it
could guarantee the repayment of commercial loans.
There would be some administrative costs associated with the pro-
vision of direc~ loans, but the principal determinant of the cost to the
government would be the level at which interest rates are set.
The inter-
est rate determines the plant's ability to pay, and consequently, the loss
rate which the government would have to absorb.
If the interest rates
were set high enough to cover the cost of government borrowing and the
loss rate, the cost to the government would be nil.
If the government
sets a lower rate, then the loan program would have losses which would
be borne by the taxpayer.
-------
~.
6-1'4
A guaranteed commercial loan has the advantage of eliminating the
major risk to banks, and the cost to t~e government is slight.
However,
even when the government is willing to guararttee a loan, under certain
circumstances banks may be unwilling to grant one.
The major federal program which utilizes guaranteed loans is
operated by the Small Business Administration (SBA) which was created
in 1953.
The SBA was set up to provide direct and guaranteed loans to
small businesses that had difficulty in raising money from private
sources.1
It was formed to ease two problems commonly associated with
bank loans:
legal lending limitations and length of maturity.
BaSi-
cally, the SBA provides longer term financing at lower rates and for
larger amounts than banks are willing to provide.
The Economic Development Administration (EDA), the principal
federal agency giving assistance to depressed areas, has two primary
low-interest programs to attract new business to these areas.
The
first is a grant and low-interest loan program to build public facilities
such as schools, sewer systems, dams, roads, sewage treatment plants
and 80 forth, which are necessary to attract business to an area. The
second program provides loans to firms to build new plants or expand
old ones in an EDA qualified 'area.
As in many other federal assistance
programs, the firm must first show that the money is not available on.
reasonable terms from private sources.
More importantly, the firm must
1.
See a1so Chapter 4.
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6-15
show that it will be able to provide new, permanent jobs and higher
incomes for the area.
In addition, th~re must be reasonable assurance
that the firm is capable of repaying the loan.
The EDA has placed its emphasis on attracting medium and large
firms to depressed areas, rather than helping small or marginal firms
come to or stay in such areas.
EDA feels that established firms with a
past record of success can most effectively bolster the economy of
these depressed areas.
Because of this, EDA tends to make a few large
loans, rather than many smaller loans.
In fiscal 1970, EDA made a total
of 40 loans to private firms which averaged just over one million dollars
per loan.
Under the Trade Adjustment Assistance Program, which has already
been refe~red to in connection with non-viable plants (see p. 6-10),
the Department of Commerce can provide either direct or guaranteed loans
for periods of up to 25 years.
Up to 90 percent of a loan can be guaran-
teed, provided the firm can show that it is unable to obtain money e1se-
where on reasonable terms.
An evaluation of the effectiveness of the
program would be premature at this stage.
Although it had been in opera-
tion for nine years as of May 1970, the Department of Commerce had pro-
cessed only 22 firm applications and 20 industry applications.
Of these,
two-thirds of the firm applications had been received during the previous
year and a half.1
1. See Summary of Investigations Under Section 301 of the Trade Expansion
Act of 1962, U.S. Tariff Commission, Office of the Secretary, June 1970
(Mimeographed).
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6.16
Variances
If no loan program is appropria~e, variances can be used to
a,~1st PQtentially viable as well as non.viable plants.
Al though a
variance permits the plant to continue polluting, there is a way in
which it might be used to encourage abatement.
Recipients could be
charged for the temporary privilege of being permitted to pollute and
the money placed in an escrow fund.
Such a policy might well persuade
financial institutions to provide a loan for pollution abatement equip.
~n.t:
first, by accumulating the necessary down payment, and secondly,
~y Q~onstrating the plant's ability to payout such sums on a long~
~erm bas is .
In this way, the variance would generate abatement funds
~ather than merely affording a period of de1ay.1
In the context of this study, viable plants are understood to
mean those which either (1) have adequate internal resources to cover
th~ costs of pollution abatement, or (2) can obtain financing from com.
m~rcial sources.
Government assistance2 would have no effect on output
or unemployment and is therefore not to be recommended.
1. This system has been utilized by tenants in apartment buildings in
several areas of the country. When the owner is responsible for housing
code violation, the rent payments are deposited in an escrow fund that
can be used only to repair the violations..
2. Tax provisions are particularly unwise, since the funds will be
counterproductive: the viable establishments can obtain rebates, while
the remainder will be worse off than before. . For a fuller discussion
see Institute of Public Administration, Governmental Approaches to Air
Pollution Control: A Compendium and Annotated Bibliography (U.S.,
Department of Commerce, Nation~l Technical Information Service, #PB 203111,
1971 ) .
-------
A P PEN DIe E S
-------
APPENDIX A
ECONOMICS OF THE INDIVIDUAL PLANT
This appendix illustrates in mathematical terms the general issues
at stake in individual plant decisions on abatement, and the potential
effects of the decision to abate on future policy and employment.
If a plant is in operation, it generally follows that anticipated
net returns exceed salvage value.
That is to say that the discounted'
cash flowl (discounted sum of anticipated revenues less out-of-pocket
costs) exceeds the scrap value of physical assets and property; i.e" the
net present value of the plant is greater than zero.
The proposition is
expressed in the foll~~ing mathematical inequality:
(1)
DCF-saNPV>OI
t - tl
where
DCF = discounted cash flow,
S - salvage value, and
NPV - net present value
The Decision to Abate
Pollutioa abatement legislation requires a decision to be m1de
by the owners of all plants:
either to comply with the regulations or
to cease operations.
An initial decisio~ if favor of a capital invest-
ment in pollutioa abatement equipment (exclusive of operating and m1in-
tenance costs) will o~ly be taken when the expenditure involved is
1. For a discussion of discountedcasb flow units, see Ezra Solomon,
'~lternative rate of return concepts and their implications for utility
regulations," The Bell JO-..1rnal of Econcntics and Management Science, I,
(Spring 1970), pp. 65-81.
-------
A-2
anticipated to be smaller than the ~unt of the discounted cash flow,
less salvage value (i.e., smaller than the net present value of the plants).
It is tmportant to note, however, that pollution abatement requirements
will result in changes in cash flow and hence, changes in the actual
net value for two reasons:
1.
Revenue will increase because price increases are
associated with an industry-wide increase in costs.
2.
Costs will change because:
(a)
(b)
operating and maintenance costs are increased, and
prices in supply markets may change.
The appropriate inequality thus becomes:
(2)
DCF +~DCF - S = NP\T +~NPV > PA
t = 0
where
~DCF = change in discounted cash flow,
.ANPV = l1DCF = change in net present value, and
PA . investment cost of pollution abatement
If the conditions expressed by this inequality (2) obtain, the plant will
abate in order to continue operations.
If the inequality does not obtain,
the plant will be unable to pay for pollution abatement and becomes
non-viable.
Differential Pollution Abatement Costs.
The general proposition expressed h~re is modified by the
frequent variation of pollution abatement costs, particularly the
initial capital expenditures required, as a proportion of sales.
Inequality (2) might therefore be rewritten as:
-------
A-3
(3)
DCF + ADCF - S - NN + ANN> Pi' + PAi
t - 0
where PA
- industry average investment cost of
pollution abatement and
PAi . differential 1avestment cost of pollution
abatement for plant i, and
LPAi . 0; by definition
In many cases, prices will increase rapidly for the industry
as a whole, by a sufficient amount that the abatement costs of most
plants are covered.
As a ro~gh approximation, it is here assumed that
the change in discounted cash fl~~ ~CF) is equal to the industry average
investment cost of pollution abatement.
In other words, only the dif-
ferential investment cost of pollution abatement is an issue.
In-
equality (3) can therefore be reduced to:
(4) DCF - S - NPV > PAi I
t . 0
That is, if the net present value of the plant (before pollution
abatement) exceeds the differential cost of pollution abatement, the plant
will ~ cease operations.
Since the sum of differential costs (PAt> within an industry is
zero,
for many plants the figure wIll be negative, and (4) will obviously
ho ld.
For others, the differential cost will be small and (4) will hold.
Only in a few cases may the differential investment costs of pollution
abatement be so gJeat that inequality (4) would be reversed, and the
plant w~uld cease operations rather than abate.
In those instances when the price increase will be delayed, in-
equality (3) cannot be reduced to (4).
In addition to the differential
-------
A-4
costs of abatement,-the plant would have to absorb some part of the
average cost figure for the industry as a whole.
It follows that
short-run plants Which also have high differential costs of abatement
will be the most likely plants to cease operations.
Future Closures
It is tmportant to recall that decisions regarding plant operation
are made on a marginal cost rather than a total cost basis.
It follows,
then, that once the investment in pollution abatement (PA) is made, it
will not affect future decisions.
I~ other words, the plant will continue
in operation for as long as the revised discounted cash flow exceeds the
salvage value:
(5) Del + !>Del - S = Nl'V + 0 I
t = tl > 0
This new situation differs'from the pre-abatement situation only
in regard to the change in discounted cash flow at a given point in
time (1.e., (5) differs from (1) only by the term ADCF).
It is unlikely
that
this change would reduce the net present value of the plant since
the increase in revenues resulting from higher industry prices will
geneIally exceed the increase in costs occasioned by the operating and
maintenance costs of pollution abatement.
It is therefore unlikely that
a plant's expected life would be reduced (once it abates) by pollution
abatement regulation.
Indeed, in the majority of cases, the life ex-
pectancy of the plant will be increased by the requirement to abate.
That is, if at some future date, without considering pollution abate-
ment, the plant would have ceased operations; i.e., when
-------
A-S.
(6)
DCF - S = NP'Il .. 0
t = tl
o~c.e the requirement was made, the following would hold
(7)
OCF + OCF - S .. NPV + ANY~ > 0
t .. tl
as
ADCF = NP'Il > 0
t .. tl
Plant Reductions in Employment
There are two instances which might result in a reduction of
the plant work force.
The first concerns abandonment of a particular
operation for which the investment costs of abatement exceed prospactive
net present value of the operation.
It is o~vious that once abatement
is carried out for a particular operation, its expected life will probably
be" extended.
O~ce abatement is carried oat, it is also possible that the
change in cash flows may induce changes in short-run decisions regarding
If this change is negative, i.e., if
- L1DCF I < 0
t .. tl t . t2 > tl
the appropriate reaction may be to reduce output and possibly employ-
employment.
(8) 6DCF
ment as well.
The importance of this is miniscule since there are
several caveats.
First» even short-run situations of this kind will
be rare because in most cases prices will rise rapidly above the 1n-
crease in costs.
Second» only where labor costs are very high in
terms of value added (i.e., well above 50 p.~rcent) wO'.11d any reduction
in work force be profitable.
Third, the possibility of losing skilled
-------
A-6
workers should give pause to management thinking of short-run layoffs.
Finally, the reduction in cash fl~~ is likely to be so small and of such
short duration that management response will probably be n1l.
Moreover,
in the longer run, inequality (8) will be reversed, and mandatory
abatement for the industry might well mean a !!!! rather than a fall
in employment for those plants that decide to abate.
J
-------
APPENDIX
B
LEGISLATIVE CONTROL OF POLLUTION ABATEMENT
Effects of Differin~ Standards
The requireme~ts for the abate~ent of pollution for a particular
plant are determined by local (state or area) implementation plans which,
in turn, depend to some extend on the observed deviation from ambient air
or water quality standards of the area.
In general, the more numerous
the sources and the more pollution each emits, the
greater will be the
burden imposed by the implementation plan.
Industriali~ed areas will
tend to have stricter standards, and consequently higher costs of environ-
mental abatement than will non-industrial areas. I
There is considerably less deviation in requirements for water
~han in those for air.
Currently, states in their pollution implemen-
,tation of plans can meet federal standards of ambient air quality in a
variety of ways so long as. the standards can be reached at all.
trast, a state's water quality implementation plan must provide that:
In con..
1.
no stream may have waste disposal as designated use;
2.
the present stream quality must not be degraded; and
3.
secondary treatment facilities be constructed.
However, in spite of these minimum requirements, there is a great deal
1. It should be noted that a considerable portion of the costs result
because emission and effluent standards do not take into account the
differing marginal costs of abatement by different industries, let alone
by different establishments within an industry. For fur~her discussion
on this point, see The Institute of Public Administration, Govermnental
Approaches to Air Pollution Control: A CanpeJldium and Annotated Biblio-
graphy (U.S., Department of Conunerce, Na.tional Technical Information
Service, #FB 203111,1971), Chapter 3.
-------
"B-2
of variance between state water programs, and particularily in en-
forcement procedures. which are almost completely in state hands.l
Water pollution
Under the Federal Water Quality Pollution Control Act, as amended
in 1965, the states are r~quired to establish water quality standards in
accordance with water uses, which implies that there may be different
standards in different parts of the same stream.
Since effluent standards
are not prescribed on a national basis, implementation plans in general
tend to vary according to the availability of water within a cammunity,2
as well as to the assimilative capacity of streams.3
One significant de-
parture from the overall trend occurs where municipalities allow industrial
1. "Federal Guidelines on Water Quality," Environmental Reporter No. 31,
(washington, D.C.: The Bureau of National Affairs, Inc., 1971), pp. 5121-3
2. Where water pollution is concerned, however, a simple urban-rural
dichotomy is not a reliable method of estimating differential pollu-
tion abatement requirements. Discharges in rural areas into a stream
frequently reach a downstream urban area with so little dilution
that they still severely affect the water quality. In a situation
such as this it may be best to frame an implementation plan in the
rural area so that it includes the effect of the discharge on the
urban area.
,)
J. The assimilative capacity of streams can differ substantially.
For example, the slower moving rivers in the South tend not to ac-
quire as much oxygen from the air as the faster flowing northern
rivers,and consequently have less assimilative capacity. This may
well be reflected (ceteris paribus) in stricter effluent standards
for, say textile plants in the South than are applied in the North.
-------
8-3
pollut~rs to use municipal waste treatment plants at costs far below
the costs of building their own plants.~
Because these benefits depend
on local considerations, one plant may obtain a competitive advantage
~ver other less fortunate members of the industry.
Air Pollution
Air pollution abatement is handled in a somewhat different manner.
The Clean Air Amendments of 1970 require that ambient air standards be
set in each air quality region, and the procedure allows little scope
for variance since the ambient air standard depends on public health
criteria.
In this respect, there is even less variation in water pollu-
tion, since state implementation plans must not permit degradation and
must allow for secondary treatment.
Even so, emission standards vary in
accordance with differences in state implementation plans, and will
generally be less stringent in areas where the air quality is already
close to satisfying national ambient air standards.
Movements toward Und formi tv of Standards
New stationary sources must satisfy a national emission "standard
of performance" which varies according to the poUutant emitted and the
size (according to process weight) ,of the source.
The 1970 Amendments
1. .Often the low cost reflects a size~ble federal grant for waste
treatment to the municipality; these may run as high as 55 percent
of total capital cost. ~he~~nicipali~ies which offer low cost
treatment do seem, howev:~, ,to b.evio:ls.ting the spirit, if not the
letter, of the Clean Wa,ter Act, si.nc~ ,the Federal government ap-
parently has lit,tle, i.f any, interest in subsidizing the treat-
ment of industrial waste.
-------
B-4
"
require all sources, when expanding or modifying their operations, to
meet the standards of performance set on a national basis for new sources.
This means that within a few years a very
substantial proportion
of the nation's industry will be required to meet uniform national
standards, rather than the varying standards of individual states and
municipalities.l
Recent federal legislation indicates that problems resulting from
differential regulations and surveillance will be limited in scope.
The
few areas with notably stiff regulations have tended to be in regions of
historically strong economic growth and resiliency (such as Los Angeles)
which would be little affected by the closing of a few operations.
Most
important, the trend of federal legislation toward national standards
indicates that legislative requirements will have a decreasing signifi-
cance in bringing about differential effects.
International Control Requirements
Although the Organization for Economic Cooperation and Development
has sought to harmonize national practices in assigning the cost of en-
vironmental protection in order to minimize possible adverse trade effects,
"
1. Promulgation of national uniform standards for both air and water
appears to be the likely result of present and proposed legislation.
On one hand, defining the issue at the national level perhaps pro-
vides conservation groups with greater and more uniform leverage
against industrialists associated with pollution whose opinions might
prevail at a lower governmental level. On _the other hand, there are
definite benefits to a system which differentiates between those
regions where substantial abatement is needed and other regions where
they are less necessary but where economic growth is more necessary.
For further discussion, see The Institute of Public Administration,
. Governmental ~pproaches to Air pollution Control: A Compendium and
Annotated BiblioRraphy (U.S., Department of Commerce, National Tech~
nical Information Service, #PB 203111,1971), especially Chapter 10,
"Questions of Adaptability."
-------
:1
,
Ii
,
iJ
I.
1
j
I
I
I
1 .
,
j
I
I
1
I
!
,
"---
._~~.
B-S
the U~s. economy is not expected to be s~gnificantly affected even if
u.s. industry has disproportional'ly higher 'costs. . Few
u.s. exports
and imports are commodities bearing high costs for pollution abate-
ment; of the total U.S. imports and exports in 1969, less than 20
percent of each were from industry groups with high costs for pol-
1ution abatement.1
Moreover, other developed nations have similar,
sometimes more severe, limitations on po1lution.2
1. . The Council on Environmental Quality, The Second Annual Report,
Environmental Quality (Washington, D.C.: GPO, August 1971), p. 133.
2.
The Finnish pulp and paper industry, a powerful
competitor and 'big dollar-earner on world export
markets, is coming under increased attack on the
question of water pollution.
Finnish industrialists reply by citing impressive
cleanup programs, arguing that they are doing more
than mills in the United States or Canada. . .
.-'
.,
John M. Lee, "Finns Attack Paper Industry on Pollution," The New
York Times, May 19, 1971.
-------
.' ~{I
\.._'~
SELECTED BIBLIOGRAPHY
Administrator of the Environmental ~rotection Agency. Report of the
Administrator. The Economics of Clean Air. Washington, D.C.:
Government Printing Office, 1971.
Bain, Joe S. Barriers to New Competition.
University Press, 1956.
Cambridge:
Harvard
Bain, Joe S. International Differences in Industrial Structure.
New Haven: Yale University Press, 1966.
Becker, Gary S. Human Capital.
Research, 1964.
New York:
National Bureau of Economic
Brennan, Michael J. Theory of Economic Statics.
N.J.: Prentice.:-Ha11 Inc., 1965.
Englewood Cliffs,
Brimmer, Andrew F. "Economic Impact of Pollution Abatement." Speech
presented at the 1971 Commencement Exercises of the Univerity
of Miami, Coral Gables, June 6, 1971.
Bylinsky, Gene.
July, 1971.
lIThe Mounting Bill for Pollution Control."
Fortune,
Cameron, Juan. "How the Interstate Changed the Face of the Nation."
Fortune, July, 1971.
Council on Economic Priorities.
Pulp and Paper Industry.
Paper Profits:
--------, 1971.
Pollution in the
(Mimeographed. )
Council on Environmental Quality.
Quality. Washington, D.C.:
1971.
Second Annual Report. Environmental
Government Printing Office, August,
"Federal Guidelines on '~ater Quality Standards." Environmental
Reporter. Washington, D.C.: The Bureau of National Affairs,
Inc., 1971. ch. 31, 5121-3.
Henderson, James M., and Quandt, Richard E. Microeconomic Theory.
New York: McGraw-Hill Book Company, Inc., 1958.
Hicks, John R.
1948.
Value and Capital.
2nd ed.
Oxford;
Clarendon Press,
Hollander, Edward D., and Others. The Future of Small Business.
New York: Frederick A. Praeger, Publishers, 1967.
Hotelling, Harold. "Stability in Competition.~'
XXXIX (March, 1929), 41-57.
Economic Journal,
;.
'1'~
-------
..-.-----.
_.
\ ;},~
[nstHute of Public Admiaistration. Governmental Approaches to Air
Pollution Control: A Compendium and Annotated Bibliography.
National Technical Information Service, Pubn. No. 203111 (1971).
tsard, Walter.
1956.
Location and Space Economy.
New York:
MIT Press,
Lee, John M. "Finns Attack Paper Industry on Pollution."
York Times, May 19, 1971.
The New
Lefcoe, George.
Inc., 1966.
Land Development Law.
Cincinnati:
Bobbs-Merrill,
Leijonhufvud, Axel. On Keynesian Economics and the Economics of
Keynes. New York: Oxford University Press, 1968.
Lerner, A. P., and Singer, H. W. "Some Notes on Duopoly and Spatial
Competi tion." Journal of Political Economy, XLV (1937), 145-186.
Lewis, W. Arthur.
Ltd., 1949.
Overhead Costs.
London:
George Allen and Unwin,
McGraw-Hill Book Company, Inc., Economics Dept. McGraw-Hill Publica-
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Nelson, Richard R., et ale Technology. Economic Growth and Public
Policy. Washington, D.C.: !he Brookings Institution, 1967.
Research Triangle Institute. "Comprehensive Study of Air Quality
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"Review and Forecast:
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Pit and Quarry, January, 1971.
Robinson, Joan.
1-8.
"Rising Supply Price."
Economica,N.S. VIII (1941),
Rose, Sanford. "Are Those 11,400 Banks Really Necessary?"
November, 1970.
Fortune,
Royal Commission on Banking and Finance.
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Report of the Commission.
Queen's Printer, 1964.
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Business. Kalamazoo, Michigan: W.G. Upjohn Institute for
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Solomon, Ezra. "Alternative Rate of Return Concepts and Their
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John
..'
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_._~
-..._~_.-
.' --...._..---
4GL
GLOSSARY
capital intensive industry: an industry which uses a relatively
large proportion of capital in relation to labor. Taking 47.1
as the average percentage for all manufacturing, as an industry
payroll falls below this percentage of value added it is more
readily defined as capital intensive. (See Table 2-1.)
demand: the call for a product by consumers within a unit of time,
combined with the power to purchase. It is determined by a
number of variables including the uses to which a product can
be put, consumer tastes and income, size of the consumer market
and the price of the product and of competative products.
cash flow: the sum of profits and depreciation allowances. Cash
flow represents the total funds that corporations generate
internally for investment in the modernization and expansion
of plants and equipment and for working capital.
differential pollution abatement costs: the proportion (in relation
to sales) by which the investment costs of pollution abatement
for an individual plant differ from th~ industry average. (Note
that for some plants this figure is less than zero since the
sum of the differential costs for all plants is defined to be
zero.
elastic: responsive to price changes. A demand or supply schedule
is perfectly elastic if an unlimited amount is demanded or
offered at all prices.
establishment:
See "plant."
firm:
a financial entity which may consist of one or more plants.
inelastic: relatively insensitive to price changes. A demand or
supply schedule is perfectly inelastic if the quantity demanded
or offered is the same regardless of price.
investment cost of pollution abatement: initial outlay on pollution
abatement equipment, design, installation, etc.
labor intensive industry: an industry which uses a relatively large
proportion of labor in relation to capital. Taking 47.1 as the
average percentage for all manufacturing, as an industry pay-
roLl exceeds this percentage of value added it is more readily
defined as labor intensive. (See Table 2-1.)
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~~
marginal cost: the additional cost that a producer incurs by making
one additional unit of output. The concept of marginal cost
plays a key role in determining the quantity of goods produced
by a plant. Marginal costs are equated to marginal revenue
(additional revenue) to obtain the highest profits.
net present value: the sum of a stream of future revenues, less the
stream of future costs, when each stream is discounted at an
appropriate interest rate.
non-viable plants: those which cannot afford to pay for pollution
abatement costs and would therefore require a subsidy if they
are to continue in operation.
plant (or establishment): a single physical entity producing goods
and services. The plant buys labor and other resource materials,
transforms these materials through a productive process, adding
value, and sells these goods or services in another market.
potentially viable plant: those which could pay pollution costs ii
they could secure a loan to cover the necessary initial outlay
but are unable to borrow the necessary funds from a commercial
lending institution.
price elasticity of demand: the percentage change in the quantity
of a commodity demanded in response to a percentage change in
the price of that commodity, when the price change is small (all
other prices assumed unchanged).
price elasticity of supply: the percentage change in the quantity
of a commodity supplied in response to a percentage change in
the price of that commodity, when the price change is small
(all other prices assumed unchanged).
resource intensive industry:
raw material.
an industry which processes a specific
short-run plants: a plant which is liable to close within a few
years even without the imposition of pollution abatement costs.
supply: the amount of a product available for purchase in a given
unit of time. For most goods, supply increases with price.
The relationship between price and supply is known as the supply
curve for the product.
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"M'''M___.-
w~
value added: the difference between the value of goods and the cost
of materials or supplies that ~re used in producing them. Value
added is derived by subtracting the cost of raw materials, parts,
supplies, fuel, goods purchased for resale, electric energy,
and contract work from the value of shipments. It is the best
money guage of the relative economic importance of a manufacturing
industry because it measures that industry's contribution to the
economy rather than its gross sales.
variable cost: a cost that depends on changes in output. As pro-
duction is increased, the variable costs increase; the reverse
is also true. Costs of this type include payments for labor,
raw materials, and other variable resources. By definition,
variable costs are zero when no product is being produced and
fixed costs are the only costs that are being incurred.
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1~
INDEX OF SYMBOLS
DCF
Discounted Cash Flow
NPV
Net Present Value
PA
Plant Investment Costs of Pollution
Abatement
PA
Industry Average Investment Costs
of Pollution Abatement
PA,
1.
Differential Investment Cost of Pol-
lution Abatement for Plant i
Note that I PA. = 0
i 1.
S
Salvage Value
t
Time
ti
Point i in Time
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--_.- ._-----< -n -.
BIBLIOGRAPHIC OAT~ 11. Report No. .
SHEET AP1D-0921
4. T ,tic and S"btltle
[2.
3. Recipient's Accession No.
Pollution Abatement and Unemploym~nt - A Methodological
Study
5. Report Date
January 31, 1972
6.
7. Author(s}
John Hoicka, Terry Trumbull and Helen Scott
9. Performing Organization Name 'and Address
8. Performing Organization Rept.
N~.
10. Project/Task/Work Unit No.
Institute of Public Administration
1619 Massachusetts Avenue, N. W.
Washington, D. C. 20036
11. Contract/GrxOt No.
EHS 70-126
12. Sponsoring Organization Name and Address
Office of Air Programs and Office
Environmental Protection Agency
5600 Fishers Lane
Rockville, Maryland
15. Supplementary Notes
of Water Programs
13. Type of Report & Period
Covered
14.
20850
16. Abstracts
A report is presented of a study which develops a methodology to estimate the magni-
tude of unemployment that may be expected as a result of plant closures caused by
pollution abatement requirements. This study is directed at the very small minority
of plants that might reduce or cease operations and thereby layoff their employees.
The report specifies the types of financial assistance required to avoid closure,
and describes the kinds of plants affected and programs which might be instituted,
should the need arise. The study also provided insights into the appropriate types
of Federal Government response, should the magnitude of unemployment warrant action.
17. Key Word. aDd Document Analysis. 17a. Descriptors
Air pollution
Water pollution
Abatement
Costs
Industrial plants
Unemployment
Finance
..
Economic analysis
Gray iron
Foundries
Portland cements
Smelters
Regulation~
17b. Identifiers/Open-Eaded Terms
Plant closures
Primary copper smelters
/
/
17c. COSATI Field/Group 13B
18. Availability Statement
, -.
1Cl.. Security Class (This
Re~?~t)., A
2U. Security Class (This
Page'
UNCLASSIFIED
21. No. of Pag~t
~/:J Jf-'
22';l~.o D
Unlimited
J
F''''''''''' NTIS-Sft 110-701
...
IIc;r"".....u"nr Anoq?o..p"Y1
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POLLUTION ABATEMENT AND UNEM-
PLOYMENT. A METHODOLOGICAL
STUDY - Institute of Public
Administration - Contract
No. EHS 70-126 - Jan. 31,1972
PB 207-109 (Coupon #HD67,389)
DATE
GAYLORD 40
ISSUED TO
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DATE ISSUED TO !
I
I
I
I
I
I
,
I
~:::o
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UNITED STATES
GOVERNMENT
PROPERTY
°hie "00 " i:; HI~ property of
tho United States Government
Notional Air Pollution Control Administration
EPA/OAP SSPCP LIBRARY
o~ll W CHAPEL HILL ST
DURHAM NC 27701
Coupon #HD67:389
(6/1/72)
APTD-0921
DATE DUE
I
EPA/OAP SSPCP LIBRARY
411 'N CHAPEL HILL ST
DUR; ./1M NC 27701
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