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Environmental regulation and incentives to comply : reviewing the economics behind forest practices enforcement strategies in British Columbia Farenholtz, Glenn Douglas

Abstract

Government, as the Principal in the Principal-Agent theory model, can maximize social welfare in setting up an enforcement structure that provides incentive for an Agent to adopt diligent behaviour. Also, society is better off providing opportunity for development and harvesting of resources on those lands where diligent behaviour will result in social welfare gains. Penalties provide incentive for firms to expend on precautionary strategies to lessen the social welfare loss of environmental damage and allow for the maximization of social welfare. Using a partial equilibrium model of social welfare from forest management activities, a definition of what penalties should be to provide optimal incentive is developed. Penalties levied under the Forest Practices Code of British Columbia Act have been described as low by the Forest Practices Board and by environmental groups due to not recognizing the value of environmental damage in the sanction. As penalties are negligence-based under the Code, they do not explicitly consider environmental damage as is shown in the derivations from the partial equilibrium model. The model describes that penalties should be greater than the difference in the cost of being diligent relative to the increased likelihood of environmental damage from non-diligent behaviour. The relative effects of that ratio are subject to social value constraints, and some consideration as to proportionality of this relationship has bearing on whether the "penalty fits the crime". Government may elect to pursue other non-financial strategies to effect compliance, as the cost of pursuing an enforcement action exceeds the expected social gains of enforcement, and therefore would be a welfare loss with a low probability of successful sanction. Economic incentive to comply is more sensitive to the probability of a penalty being applied than the size of the penalty and therefore actions that increase the successful application of a sanction, for example making regulations and standards clearer and more enforceable, will assist in providing for increased incentive to comply.

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