Journal of Public Economics 72 (1999) 361378

Regulatory dealing revisiting the Harrington paradox q

Anthony Heyes a , *, Neil Rickman b
a

Department of Economics, Royal Holloway College, University of London, Egham Hill, Egham, Surrey TW20 0 EX, UK b University of Surrey, Surrey, UK Received 1 June 1997; received in revised form 1 February 1998; accepted 10 June 1998

Abstract Despite the fact that (i) when the EPA observes regulatory violations it rarely pursues the violator and, (ii) the expected penalty faced by a violator who is pursued is small compared to the cost of compliance, it is still the case that, (iii), rms comply a signicant portion of the time. Winston Harrington (Harrington, W., 1988. Enforcement leverage when penalties are restricted. Journal of Public Economics 37, 2953) provides a dynamic model consistent with this apparent paradox. We offer an alternative rationalisation in a model of regulatory dealing in which the agency uses tolerance in some contexts to induce increased compliance in others. The observed tolerance of the EPA to non-compliance may be a strategic response by the agency to a difcult enforcement environment rather than evidence that it has gone soft on pollution or been captured by industry interests. We use the model to consider the impact of the growing trend towards citizen suits and NGO enforcement of regulation, arriving at some unconventional conclusions. We argue that the model is consistent with existing empirical analyses. 1999 Elsevier Science S.A. All rights reserved. Keywords: Environmental regulation; Enforcement JEL classication: K32; K42

1. Introduction Winston Harrington, 1988 (p. 29) and others have noted the following paradox
*Corresponding author. E-mail address: a.heyes@rhbnc.ac.uk (A. Heyes) q We are grateful to Lars Hansen, Robert Cairns, Jeff Frank, two referees from this journal and seminar participants at the University of London for helpful comments. The usual disclaimer applies. 0047-2727 / 99 / $ see front matter 1999 Elsevier Science S.A. All rights reserved. PII: S0047-2727( 98 )00098-X

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in the context of enforcement of environmental standards in the US: Despite the fact that (i) when the EPA observes violations it often (almost always) chooses not to pursue the violator and, (ii) the expected penalty faced by a violator who is pursued is small compared to the cost of compliance, it is still the case that, (iii), rms are compliant a signicant proportion of the time.1 In a number of other enforcement contexts authors have noted that compliance rates seem to be higher than would be justied by the expected penalties for non-compliance. Harrington provides a dynamic model consistent with these three apparently contradictory stylised facts. In a repeated enforcement / compliance game with restricted penalties the EPA maximises the rate of steady-state compliance by operating a state-dependent enforcement regime. In the simplest case the agency groups sources according to recent inspection-history (group 1 containing rms found to be compliant at last inspection, group 2 those found non-compliant) and levies no penalty upon a group 1 rm caught violating but a maximal penalty upon a group 2 rm caught likewise. A representative rm can be induced to comply some of the time (in particular when resident in group 2) even though the limit on penalties is such that if all violations were penalised with certainty it would never choose to do so. The state-dependent penalty regime generates what Harrington refers to as penalty leverage: When in group 2 a sources incentive to comply is not just the maximal penalty which it avoids but also the present value of reinstatement to group 1 and the laxer treatment which that entails in the next period.2 In equilibrium non-zero compliance is achieved despite penalties never being levied.
1 Harrington (1988) provides evidence of these and other stylised facts on pages 2932 (especially Table 1). When a violation is discovered by far the most common response is for the agency to send the rm a Notice of Violation (NOV) but take no further action. The reticence to use penalties is exhibited in Table 1 which reports the results of an RFF survey of state-level enforcement activity conducted in 1984. Most states levied penalties for less than 5 percent of NOVs issued each year. Also, the size of penalties is generally very small (Harrington, 1988: 30). To take a typical example Connecticut of 800 known violations (i.e. cases where NOVs were issued) in an average year penalties were assessed in only 21 cases and the average penalty collected in those 21 cases was $221. See also Russell (1990) for an excellent empirical and anecdotal analysis of the USEPAs enforcement environment and programme. Similar empirical regularities with compliance seeming to be higher than would be justied given the frequency with which violations are penalised and the size of those penalties exist in other countries. In particular see Hawkins (1983) for an analysis of the UK: (h)ow are rules enforced . . . when legal sanctions are widely regarded as derisory, and when the regulated have good economic incentive not to observe the law? (Hawkins, 1983: 37). 2 The earliest state-dependent enforcement models of this sort (both from the tax enforcement literature) are due to Greenberg (1984); Landsberger and Meilijson (1982). Such models offer a justication for agency blacklists and are consistent with the empirical nding that agencys deal more harshly with repeat offenders. Harringtons 1988 model was reapplied in Harford and Harrington (1991) to the case in which the EPA could also choose the stringency of the regulatory requirement. We abstract from the resulting complications in the model presented below by assuming compliance decisions to be binary.

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In this paper we provide a static model consistent with the same set of stylised facts. The basic assumption underlying the analysis here is that the EPA interacts with a particular rm in more than one enforcement context or domain. This is realistic. It may be that the agency enforces the same rule or regulation at more than one plant of a multi-plant rm, or in more than one geographical region in which the rm operates. It may, equally, enforce several different sets of regulations those regarding airborne emissions, waterborne discharges, noise etc. at a single plant (Yaeger, 1991). In that case, when penalties do not permit full-compliance to be achieved, the EPA may be able to improve upon the overall level of compliance generated by a policy of full-pursuit (penalising all violations with certainty) by engaging in regulatory dealing. A regulatory deal involves the agency agreeing (perhaps tacitly) to tolerate non-compliance in some sub-set of domains in exchange for compliance in others. In Section 2 we set up the model and characterise the circumstances in which dealing works. The observation that the EPA is often seen to tolerate observed violation is not evidence that it has gone soft on pollution or been captured by those it is supposed to police. Such tolerance is, rather, an integral part of an overall enforcement strategy which maximises environmental protection. We show, perhaps surprisingly, that the gains from dealing will not in general be monotonic in the degree to which penalties are restricted. In Section 3 we use the model to consider the impact of the growing trend towards private (or citizen) enforcement, arriving at some unconventional conclusions.

2. Model The rm and enforcement agency interact in more than one domain. This may arise because a single agency is responsible for enforcing more than one regulation or because it enforces the same regulation at more than one constituent plant of a multi-plant rm. For simplicity we will assume that the number of domains is two and that they are ex ante identical. In each domain the rm is required to comply with a regulation. If it complies it inicts no environmental damage otherwise it inicts damage d, which is commonly observed. The cost to the i th rm of compliance in domain j [ h1, 2j will be denoted c ij where c i 1 and c i 2 are independent, privately observed draws from a distribution f (c) with associated cumulative F(c). F is common knowledge. If the agency observes non-compliance by a rm in either domain it can take that rm to court (pursue the rm), in which case the rm is subject to a penalty L which is exogenous. Penalties are assumed to be restricted in the sense that

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F(L) , 1. This implies that a policy of full-pursuit, whereby the agency pursues all violations, will not generate full-compliance.3 The rm and enforcement agency are both risk neutral and aim to maximise expected prot and minimise expected environmental damage respectively.

2.1. The full pursuit benchmark

Under full-pursuit rm i chooses to comply in domain j iff c ij , L (1)

The expected environmental damage done by a representative rm under such a regime (remembering that each rm operates in two domains) is then D 5 2d(1 2 F(L)) . 0 (2)

(Any mixed strategy in which the agency pursues violation with some probability B , 1 implies a lower rate of compliance and a higher expected environmental damage 2d(1 2 F(pL))).

2.2. Equilibrium with regulatory dealing

A regulatory deal between the enforcement agency and the rm will take the form of the agency agreeing not to pursue violations by that rm in one domain in exchange for the rm complying in the other.4 In characterising equilibrium behaviour when such a deal is offered by the agency it is useful to distinguish four classes of rms: [a ] L , Minhc i 1 , c i 2 j , 2L: Under full-pursuit a rm in this category complies in neither domain. It accepts the regulatory deal and elects to comply only in that
The assumption that F(L) , 1 is critical to the relevance of the analysis. Harrington argues that penalties may either be restricted formally (e.g. by statute) or effectively by the constraints of implementation: Even when a maximum ne is not imposed by statutes there may be a practical or political limit to the size of penalties (p. 32). See also Heyes (1996); Yaeger (1991). Hawkins (1983) argues that penalties are even more restricted outside the US: The reference to the low level of sanction is made with the British position in mind. The American regulatory agency is armed with legal sanctions fearsome in comparison (Hawkins, 1983: 69). He provides examples of specic categories of violation where the maximum penalty that can be levied is, to take one example, 200, a sum signicantly below what compliance might reasonably be expected to cost. L could be interpreted more generally as the expected penalty faced by a non-compliant rm pursued. 4 Note that the structure of the problem is such that we can abstract from the issue of commitment. Neither side has an incentive to renege on any deal once struck. We rule out the possibility of mixed strategy deals under which the EPA would agree to pursue violation in one domain with some probability less than one but greater than zero in exchange for compliance in the other.
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domain in which its compliance cost is lower. Environmental damage inicted by the rm across the two domains decreases from 2d to d. [ b ] Maxhc i 1 , c i 2 j , L: Under full-pursuit a rm in this category complies in both domains. It accepts the regulatory deal when offered since minhc i 1 , c i 2 j , (c i 1 1 c i 2 ) and then complies only in that domain in which its compliance cost is lower. Environmental damage inicted by the rm across the two domains increases from 0 to d. [g ] Minhc i 1 , c i 2 j . 2L: Under full-pursuit a rm in this category complies in neither domain. It rejects the regulatory deal. [s ] c i 1 . L . c i 2 : Under full-pursuit a rm in this category complies in and only in domain 2. It accepts the regulatory deal when offered since minhc i 1 , c i 2 j , [minhc i 1 , c i 2 j 1 L] but continues to comply only in domain 2. Environmental damage inicted by the rm across the two domains remains d.

2.3. Dealing and the environment

In the absence of dealing we have seen that the best enforceable level of compliance implies residual damage D . 0 (dened in Eq. (2)). When will dealing allow the agency to further reduce damage? Because rms are identical to an external observer (information regarding their compliance costs in the two domains is private) the agency cannot target its dealing, either it deals with a representative rm or it doesnt.5 Given that the agency is interested only in environmental protection types g and d can be ignored dealing does not effect their environmental performance. The environmental pay-off from dealing arises from the existence of type a rms. Under full-pursuit the rm never complies because c i 1 , c i 2 . L. When offered a deal by the EPA (the offer is, effectively: comply in one domain in exchange for us turning a blind eye to violation in the other) the rm accepts with a resulting reduction in environmental damage. Suppose, for illustration, that L 5 100, ci 1 5 125, c i 2 5 150. When all violations are pursued the rm makes its compliance decision on a domain-by-domain basis and, since c i 1 , c i 2 . L, violates in both. Its overall burden is then 2L or 200. When offered a deal the rm accepts and saves penalty in both domains by agreeing to comply in one, cutting its costs to minhc i 1 , c i 2 j 5 125. The improvement in compliance induced from these rms must be weighed against the diminished compliance of b -type rms.
5 It makes no substantive difference whether we model the behaviour and expected performance of a single randomly selected rm or of a population of n ex ante identical rms. To save notation we do the latter.

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Starting from full-pursuit we can dene a (L) to be the probability that a rms environmental performance will be improved by the introduction of dealing. Then,

a (L) 5 2(1 2 F(L))(F(2L) 2 F(L)) 2 (F(2L) 2 F(L))2

(3)

(to be counted here the rm has to get one draw between L and 2L, the other anywhere greater than L). In each case dealing leads the rm to reduce its total pollution by d. Similarly, dene b (L) to be the probability that a rms environmental performance will worsened as a result of the introduction of dealing, then

b (L) 5 F(L)2

(4)

(to be counted here a rm has to get two draws less than L). The introduction of dealing worsens the performance of such a rm by an amount d. Starting from the full-pursuit benchmark, the impact of the introduction of dealing on expected damage per rm can be written

D(L) 5 d(a (L) 2 b (L))

The following is true by construction:

(5)

Proposition 1. The introduction of regulatory dealing will enhance compliance ( improve the environmental performance of the industry), i.e. D . 0, iff 2(1 2 F(L))(F(2L) 2 F(L)) 2 (F(2L) 2 F(L))2 . F(L)2 This is an interesting result. Maximal enforcement (full-pursuit) will not necessarily imply maximal compliance strategic tolerance of non-compliance in particular domains may improve aggregate performance. The observation that EPAs frequently let off violators does not necessarily imply that the agency has gone soft on pollution or been captured by the regulated population (Boyer and Meidinger, 1985: 837). It may, rather, be a feature of a compliance-maximising enforcement regime. The inequality in Proposition 1 warrants further consideration. Fixing F(L) the condition dictates that dealing will enhance aggregate compliance if F(2L) is sufciently large. That this should be so is straight-forward to understand. The benets of dealing come from the improved performance of type a rms, rms with L , Minhc 1 , c 2 j , 2L. For dealing to work overall requires that there be more rms of this type than there are b s. Fixing F(L) at some arbitrary level xes the number of type b rms at F(L)2 . For dealing to work then requires that a(L) . F(L)2 which requires that there be sufcient probability mass between F(L) and F(2L), i.e. requires F(2L) be sufciently large (a is everywhere increasing in F(2L)). It is interesting to note that D is not necessarily decreasing in L, raising penalties may increase the gains from dealing. This is most easily shown by

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Fig. 1. Relationship between gains from dealing and penalty for c ij | U[0, 1].

example. In Fig. 1 we plot the relationship between D and L for the case in which c ij |U [0, 1]. The gains from dealing are non-monotonic in L reaching an interior maximum of (d / 4) at L 5 1 / 4 (i.e. if L happened to equal 1 / 4 then dealing would deliver a 25% improvement in compliance over the full-pursuit benchmark). Dealing is unable to deliver compliance-gains for L . 1 / 2. The inverted U-shaped relationship between D and L is unsurprising for the case in which c ij is uniformly distributed. When L is very low there are few type b rms and many type g s. Increasing L from a starting point of zero will, for a while, move rms from type g to type a without affecting the number of b s. A reverse argument can be made for L sufciently large (sufciently close, more concretely, to 1 / 2). The uniform distribution implies that DLL (L) , 0 and ensures a smooth transition from the upward-sloping to the downward-sloping parts of D(L). The intuitions about the extremes are general. This can be seen by noting that

DL (0) 5 2.FL (0) . 0

and

(6)

DL ((1 / 2)) 5 2 2.FL (L) , 0.

(7)

That DLL (L) is everywhere negative, however, is a result of the specication chosen. Log-concavity of F is not sufcient to ensure this. The best implementable equilibrium, then, from the point of view of the agency, involves dealing when D(L), full-pursuit otherwise. Though the gains to dealing may be non-monotonic in L it is apparent that an increase in L cannot decrease

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the overall rate of compliance in the best implementable equilibrium, i.e. cannot increase expected environmental damage. (This is proved in Appendix A).

3. Private intervention and the environment A feature of the last two decades has been the growing trend towards private enforcement of environmental regulations, with individuals and (more frequently) environmental interest groups taking legal action against non-compliant rms not pursued by the regulatory agency. Before 1970 in the US governmental agencies held exclusive enforcement rights. In 1970, however, Congress amended the Clean Air Act to allow interested private parties to pursue non-compliant rms which the EPA failed to pursue. Since then similar provisions have been built into other statutes (including the Clean Water Act (CWA) and Toxic Substances Control Act (ToSCA)). The number of citizen suits has increased dramatically since the early 1980s and private actions now represent a substantial proportion of the total.6 Despite the growing importance of private enforcement actions there has been little or no attempt to model its implications for the efcacy of the overall enforcement effort: While the role of NGOs in environmental policy is growing rapidly, our analytical understanding of the consequences of this emerging role has not kept pace (Naysnerski and Tietenberg, 1992). Existing conventional wisdom is that the increased intervention of NGOs against violators whom the EPA fails to pursue must improve overall compliance: Adding the likelihood of a private enforcement action to that of public enforcement implies a higher probability that a non-compliant rm will be penalised which . . . should increase the observed degree of compliance with the regulation (Naysnerski and Tietenberg, 1992: 43). Similar logic allows Fardil (Fardil, 1985: 80) to arrive at the conclusion that (C)ongressional authorization of citizen suits . . . can only serve to have promoted compliance with environmen-

6 The Refuse Act, in light of a Supreme Court decision in 1966, . . . laid the legal foundation for citizen suits against polluters when the government failed to prosecute ((Yaeger, 1991: 120), italics in original). The litigating mechanism is known as a qui tam action, lawsuits rooted in ancient common law that provide for citizen suits in the failure of government to enforce law. In the early 1980s (H)igh rates of non-compliance with the water pollution and other laws generated private enforcement at a level not before seen in American regulatory law (Yaeger, 1991: 320). In the 5 years before 1983 private groups les only 41 notices to sue and lawsuits under the water law (Fardil, 1985: 34), in 1983 he number was 103, 87 in the rst quarter of 1984. This activity, much of it organised by various national environmental groups, began to rival the federal governments own enforcement action: of the 108 actions in 1983, 62 eventuated in actual citizen lawsuits, compared to the 77 suits led by the Justice Department on behalf of the EPA (Yaeger, 1991: 321).

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tal laws.7 Such a result follows straight-forwardly from a model in which the EPA operates a random but incomplete enforcement programme. As soon, however, as one allows the EPA to do anything more sophisticated than this such as to engage in regulatory dealing with rms with which it has multi-context contact then the conventional wisdom needs to be rethought. In these cases the decision not to pursue violators in particular contexts is a strategic and complianceenhancing one by the EPA and subsequent intervention by a private enforcer could be expected to compromise the overall efcacy of the enforcement regime.

3.1. Regulatory dealing in the presence of private enforcement action

We model private enforcement action as a random activity, with private litigants pursuing some fraction c of incidents of non-compliance not pursued by the EPA.8 It is natural to assume that the EPA has rst refusal on whether or not to pursue a particular offence. Not only will private actions generally be based upon information originally collected by the public agency (Yaeger, 1991), to which that agency can be assumed to have earliest knowledge, but private agencies are also required to le a 60-day notice of intent to le, a provision built into US legislation with the specic purpose of giving the government agency a last chance to consider its own (in)action. A private action is assumed to have the same likelihood of success and penalty implications as a public action. The value of c, is common knowledge and measures, then, the propensity for private enforcement. Starting from the full-pursuit benchmark characterised in Section 2.1 we can analyse the efcacy of dealing for an arbitrary c on the closed unit interval

7 Conventional wisdom may be driven by the implicit assumption that an environmentallymotivated EPA only fails to pursue a known violator because of shortage of resource, such that private action would be doing the EPA a favour by pursuing cases that the EPA would have liked to pursue but simply couldnt afford to. In the current model no assumption has been made that the EPA is resource-constrained nor, indeed, has pursuit assumed to be costly. In an equilibrium with dealing the EPA lets rms off because and only because so doing enhances aggregate compliance. 8 To be absolutely explicit, let Y be the statement The NGO pursues the rm and Z the statement The EPA pursues the rm then P(YuZ) 5 0 and P(Yu | Z) 5 c. There would, of course, be other ways in which NGO intervention could sensibly be built into this model. The dispersed and uncoordinated nature of private action makes it plausible to model private action as an essentially random mopping up of violations left unpursued by the agency, with c being the propensity for private litigants to pick up such cases. Note that the role of private suits here is to impose penalty (rather than, say, to recover damages). This is realistic: Typically the role of civil actions is to make damaged parties whole; any resulting change of incentives is generally a by-product of this primary quest for corrective justice. The citizen suit, by contrast, inverts these priorities. Deterrence and determining the effective content of enforcement policy are the primary purposes of these suits . . . no attempt is made to dene or remedy private wrongs. The private litigants hope to step into the governments shoes in a rather literal sense . . . when government agencies are unwilling or unable to enforce regulatory laws as they should be enforced (Boyer and Meidinger, 1985: 836)).

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(Section 2.3 rehearsed, in effect, the special case in which c 5 0). Ignoring for brevity those rms whose behaviour is not altered by the introduction of dealing we can now denote the number of rms whose performance is enhanced (diminished) by dealing as a (L, c ) and b (L, c ) respectively. For the compliance of a rm to be enhanced it must be that

L , minhc 1 , c 2 j , (2 2 c )L
implying that

(8)

a (L, c ) 5 2(1 2 F(L)).(F((2 2 c )L) 2 F(L)) 2 (F((2 2 c )L) 2 F(L))2

(3b)

(note that this reduces to Eq. (3) for c 5 0.) For performance to be worsened by dealing requires that

cL , maxhc 1 , c 2 j , L
implying that

(9)

b (L, c ) 5 F(L)2 2 F(cL)2

(4b)

(note, again, that this reduces to Eq. (4) when c 5 0.) Straight-forward differentiation of Eqs. (3b) and (4b) yields the following: Proposition 2. a and b are both (weakly) decreasing in c, an increase in the propensity of the private sector to enforce reduces both the proportion of rms whose environmental performance is improved by dealing and the proportion whose performance is diminished. (Proof in Appendix B). Of particular note is that a, the number of improvers, is decreasing in c. Dealing works by the EPA effectively bribing a subset of rms to comply in one domain with a promise of preferential treatment (tolerance of non-compliance) in another. An increase in c reduces the value of such a bribe to a rm because even if let off by the agency the non-compliant rm may still face private pursuit (of course if c 5 1 the EPAs tolerance is of zero value to the rm). This reduces the range of rms from which the agency can buy improved performance. Recognising that the full-pursuit benchmark is invariant to c it is useful to compare the net environmental gains from dealing and see how they depend upon c. The net environmental gains from dealing are

D(L, c ) 5 d(a (L, c ) 2 b (L, c )).

(10)

For a given L the impact upon expected environmental damage under dealing of a marginal change in c is described by

Dc (L, c ) 5 d(ac (L, c ) 2 bc (L, c ))

(11)

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the sign of which is, in general, ambiguous. The derivatives ac and bc are both (weakly) negative; an increase in c reduces the proportion of rms whose environmental performance is improved by dealing (a bad thing) but, at the same time, reduces the proportion of rms whose performance is diminished. The overall impact will depend upon the relative size of the two effects and cannot be determined in general. It is apparent that the impact of NGOs upon the total rate of compliance in the best implementable equilibrium is, accordingly, ambiguous. The best implementable equilibrium involves dealing if D(L, c ) . 0, full-pursuit otherwise. Necessary and sufcient conditions for a marginal increase in c to decrease the overall rate of compliance (i.e. for the perverse case to hold) are that D(L, c ) . 0 and) Dc (L, c ) , 0. In policy discussions private enforcement is sometimes claimed to be a substitute for public enforcement (in the sense that an increase in one might be expected to off-set a decrease in the other) and sometimes a complement (in the sense that more of one might be expected to increase the efcacy of the other). Whichever interpretation is adopted private and public enforcement action may, in the current model, be substitutes or complements.9 The former may or may not work in the same direction as the latter and may or may not increase the efcacy of the latter. A difculty in interpreting the relationship between private and agency actions is that c measures a propensity rather than equilibrium quantity. One can, however, show the following: Proposition 3. In an equilibrium with dealing the number of cases pursued by a compliance-maximising EPA is increasing in c. The number of cases pursued by private agencies may be increasing or decreasing in c. (See Appendix C). The rst part of the proposition is interesting and is implied by the fact that an increase in c increases the ow of uncondoned violations. The expectation of private enforcement at a rate c reduces the propensity for rms to engage in dealing with the agency and so increases the number of cases in which the agency pursues non-compliance. The second part reects the possibility of a Laffer curve type story. An increased propensity for private enforcement may, in equilibrium, cause a substantial enough reduction in the number of violators not pursued by the EPA that the total number of private enforcement cases may actually go down.

9 The ambiguity arises because whilst the prospect of private enforcement induces some rms to reject the deal and comply in neither domain, it also encourages some rms to reject the deal and comply in both domains (an outcome not observed under dealing without NGO activity).

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4. Analysis and conclusions Most models of enforcement predict that compliance rates are (at least weakly) increasing in enforcement effort. When, however, penalties are restricted as Harrington (1988) and others have argued is often the case in environmental contexts this conventional wisdom breaks down. Greenberg (1984) Harrington (1988) and others have shown that when penalties are restricted higher rates of compliance can be generated by a state-dependent enforcement policy than by a policy of full pursuit. Here we present a mechanism by which regulatory dealing can improve upon the compliance rates generated by full-pursuit in cases where the EPA and rm have multi-context enforcement contact. The resulting equilibrium is consistent with the apparently paradoxical stylised facts outlined in the rst paragraph of the paper and represents an alternative to the dyanamic-incentive story told by Greenberg, Harrington and others. The mechanism is best understood by considering a simple example in which the EPA regulates the rm in two domains. In each domain compliance would cost the rm 10 whilst the maximum penalty for non-compliance in a domain is 8. A policy of full-pursuit achieves zero compliance. Under a dealing regime, on the other hand, the rm complies in one domain in exchange for non-compliance in the other being tolerated and a compliance rate of 50% is achieved despite the fact that in equilibrium the EPA never imposes a penalty on known violators. Whilst we have abstracted from monitoring costs in this paper it is apparent that, in addition to the compliance gains, dealing could be expected to deliver savings in enforcement costs. This arises from the fact that under the terms of a deal, monitoring would be unnecessary in that domain in which the rm had elected to be allowed to violate.10 The mechanisms characterised in the state-dependent enforcement literature and here share a common avour. In the former there are inter-temporal linkages between agency responses to non-compliance, here there are horizontal linkages. Regulatory dealing could be seen as a way of generating horizontal penalty leverage, effectively providing a mechanism whereby individually inadequate penalties from a subset of domains can be aggregated and used to buy compliance in the rest. The recognition that non-pursuit of some violators may enhance compliance yields the counter-intuitive possibility that enforcement effort (as measured by number or proportion of violators pursued) and compliance may be inversely related. The observed tolerance of EPAs to violation in some contexts may be a strategic response of the agency to a difcult enforcement environment, rather than
10 We are indebted to a referee for this point. In constructing a model of incomplete enforcement we did not want any of the results to be driven by consideration of enforcement costs. Taking account of enforcement costs would certainly be important in any subsequent normative analysis.

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necessarily evidence that it has gone soft on pollution. The recognition also leads us to rethink the conventional view that private enforcement action taken by NGOs and other interested parties will necessarily be good for the environment. Once the strategic role of waivers is understood it is straight-forward to understand that private enforcers choosing to pursue violators that the EPA has chosen not to pursue may undermine the incentive properties of the enforcement system.11 Opposition by agencies in various countries to the extension of private enforcement rights has been interpreted cynically: (a)gencies resist private enforcement in the belief that the plaintiff groups are intruding on bureaucratic turf (Boyer and Meidinger, 1985: 841). The analysis presented here suggests a more positive interpretation of such opposition.12 Melnick notes that Everyone familiar with the EPAs enforcement program recognises that its use of administrative orders (as opposed to civil penalties) constitute a mechanism for excusing non-compliance. Environmental groups complain that such orders.. serve mainly to prevent citizens from suing polluters under Section 304 (Melnick, 1983: 173). This behaviour is also consistent with an environmentally-motivated EPA attempting to sustain an equilibrium with dealing. The analysis also shows that any empirical effort to assess the efcacy of private enforcement effort cannot take a partial equilibirum approach, just focussing on those areas in which NGOs are active. The existence of spill-overs into performance in other sectors means that a broader measure must be used. In so far as dealing is actually or potentially important the current model also suggests that, other things equal, a broad-based enforcement agency is likely to be able to achieve higher rates of compliance than a group of smaller ones. An agency that covers a wide geography and / or a variety of media is more likely to be able to identify and implement compliance-enhancing deals than one with a narrower range of jurisdiction. The Reorganisation Plan No. 3 of 1970 created the USEPA and . . . for the rst time centralised the 15 federal programmes for controlling air and water pollution, environmental radiation, pesticides and solid wastes, pulling these programs together from their previously diverse residences in the Departments of Agriculture, Interior and HEW. Later, ofces handling noise (1971) and toxic waste (1972) were added (Yaeger, 1991: 115). Our analysis

In a recent paper Briggs et al. (1996) also argue, though in a different context and through a quite different mechanism, that citizen enforcement of regulation may hinder the efciency of the public enforcement process. Section 4 of the US Clayton Act permits a private plaintiff to use ndings from a prior antitrust suit brought by the government to pursue a treble damage suit against the same defendant for the same conduct. A violators incentive to signal a strong case to deter a triple damage suit forces the government to pursue more cases than it would otherwise (anticipation of private pursuit in the second period induces the rm to change the way it responds to public pursuit in the rst). 12 The story here would be that some plants might be complying with the machine-guarding rule (despite the fact that so doing does not seem to make economic sense) in exchange for tolerance of its non-compliance with some other OSHA-enforced regulation.

11

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suggests that this centralisation (one recently mimicked by the establishment of a single national Environment Agency in the UK) can be expected to have increased the scope for dealing and hence made enforcement easier. The state-dependent models and the current model generate distinct testable hypotheses. Models of the Harrington (1988) sort predict particular inter-temporal regularities; in particular a rm issued an NOV in period t should be more likely, ceteris paribus, to comply in the next, whilst a rm found compliant in period t should be more likely to violate in the next. The regulatory dealing model, on the other hand, predicts certain cross-sectional regularities. A rm found non-compliant in one domain should be more likely to receive an NOV (as opposed to being pursued for penalty) if it is compliant in other domains. This prediction is consistent with, for example, the cross-sectional analysis of Gray and Deilys (Gray and Deily, 1996) study of air pollution regulation in the US steel industry. They nd (Table IV: FCOMPL variable) that enforcement pressure at plant j is decreasing in compliance at other plants belonging to the same rm. They also nd that other things equal, regulators are more likely to act against single-plant rms (p. 108) which, across a population of rms, is consistent with dealing reecting the comparative lack of opportunities that a single-plant rm may have to engage in it. Dealing, formal or informal, is also consistent with Weils (Weil, 1996) analysis of the OSHA enforcement programme. In a case study of compliance with machine-guarding standards in the custom woodworking industry he nds substantial rates of compliance (around 43%) despite the fact that inspection probabilities are low and nes levied on rms caught violating are meager. He calculates that given observed inspection and reinspection rates rms should only comply if the cost of so doing is less than about US $200 and then presents evidence that this gure is dwarfed by the actual cost such that the enforcement programme . . . provides little reason for compliance (Weil, 1996: 625). He concludes that (E)stablishments choose to comply with OSHA standards beyond what one would expect given low expected penalties . . . OSHA seems able to elicit establishment reactions as if it were an ogre even given relatively toothless enforcement (p. 619). Longitudunal analysis of 671 rms between 1972 and 1991 allowed Weil to take account of Harrington-type dynamic incentives, but once these are taken into account there remains substantial (apparent) over-compliance which would be consistent with dealing (see also Magat and Viscusi, 1990). He also nds that, other things equal, a plant which is a part of a multi-plant rm is more likely to comply than is an analogous plant which is not. Whilst the models do yield distinct testable hypotheses acceptance of one, as Weils results suggest, should not be taken to imply rejection of the other. It is realistic to suppose that with most rms the EPA interacts both across a variety of enforcement contexts and through time. In that case specication of optimal policy will be particularly difcult, with the potential for enforcement stance in domain i

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in period t to be conditioned not only on compliance-history in i but also on current and past performance in other domains. The agency could reasonably be expected to use both horizontal and dynamic incentives in combination. So is regulatory dealing used by enforcement agencies? From the point of view of motivating the current paper it doesnt really matter; either it is used in which case the model presented here is of explanatory interest, or if it is not then the analysis serves to make the case that perhaps it should be in a range of contexts in which penalties are undoubtedly restricted. Of course, in so far as EPAs do deal we would not expect that dealing to be as explicit or formalised as the earlier stylised analysis might have suggested. There is, nonetheless, anecdotal evidence of bargained outcomes of one sort or another in the US, with the EPA engaging in various types of horse-trading in order to coax improved performance out of recalcitrant enforcees (see, for example, Scholz (1991); Yaeger (1991); Shover et al. (1996)). In the UK Hawkins notes that Bargaining between regulatory ofcers and polluters is central. Compliance works because it is an exchange relationship and furthermore, in light of our modelling, forebearance having the discretion to let a source off is the ofcers major bargaining resource (Hawkins, 1983: 47). When and whether dealing of precisely the sort envisaged here is or should be used will depend critically upon the distribution F of compliance costs and remains for empirical investigation. In this paper we have adopted the assumption, conventional in the literature, of assuming that the job of the enforcement agency is to enforce. This is realistic and analytically appropriate (see, e.g., the discussion on p. 256 in Heyes (1996)). The purpose of the model has been positive-trying to provide a model with realistic features that is consistent with a set of apparently paradoxical observations. In a fuller model it might be useful to derive some of the normative implications of dealing. Maximising compliance could be made to coincide with maximising welfare such that normative and positive results moved in the same direction by adding, for instance, the assumption that the support of c is the unit interval and that d is greater than or equal to unity (such that more compliance is always good, a popular implicit assumption in much of the enforcement literature). Alternatively, things could be kept more general. It would be important to note when making normative judgements that dealing could be expected to have distributional as well as aggregate implications (the scope for distributional consequences can, in fact, be used to rationalise private actions in a world in which such private actions have adverse aggregate consequences). It might also be useful, in such an extended version of the model, to include monitoring costs (we have already noted that dealing could, in any given context, be expected to yield a saving in enforcement resources). The model presented has, of course, been highly stylised. A number of ways in which it could sensibly be developed spring to mind. These include endogenising some of the things that are currently not explained within the model; generalising the analysis to the case of non-binary compliance decisions; and further exploring

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the potential for strategic interaction between the EPA and NGOs in their respective enforcement activities. These things remain for future research.

Appendix A The best (i.e. compliance-maximising) implementable equilibrium involves dealing if D(L) . 0, full-pursuit otherwise. Expected environmental damage (D ) in the best implementable equilibrium then equals h2.d.(1 2 F(L)) 2 D(L)j if D(L) . 0, 2.d.(1 2 F(L)) otherwise. The impact of a marginal increase in L upon D, then, equals 2 2.d.FL (L) , 0 if dealing, or 2 2.d.FL (L) 2 DL (L) 5 2 2.FL (2L).(1 2 F(2L)) , 0 (A.1)

if not. In either case increasing L reduces expected environmental damage (increases compliance).

Appendix B Differentiating the expression in Eq. (3b) with respect to c yields

ac (L, c ) 5 2 2.L.Fc ((2 2 c )L).(1 2 F((2 2 c )L))

(A.2)

which is non-positive. Differentiating the expression in Eq. (4b) similarly yields

bR (L, c ) 5 2 2.L.Fc (cL).F(cL)

(A.3)

which is non-positive. Note that ac (L, c ) may be less than, greater than or equal to bc (L, c ) depending upon the specication of F.

Appendix C For the EPA to pursue a violator in an equilibrium with dealing requires that the source involved rejects the deal and subsequently violates (we will refer to this as uncondoned violation). The expected number of uncondoned violations per rm is then 2.(1 2 F((2 2 c )L))2 Differentiating this with respect to c yields 4.L.FL (1 2 F ) (A.5) (A.4)

which is positive. The private sector pursues a fraction c of condoned violations.

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The expected number of condoned violations per rm is [1 2 (1 2 F((2 2 c )L))2 ] meaning that the expected number of cases privately pursued (per rm) is

c.[1 2 h1 2 F((2 2 c )L)j 2 2 F(L)2 ]

(A.6)

(one minus the proportion of uncondoned violations minus the proportion of rms that do not violate). Using V to denote the expression in square brackets in Eq. (A.6), differentiation with respect to c yields

V 2 2.c.L..FL ((2 2 c )L)(1 2 F((2 2 c )L))

(A.7)

which cannot be signed without additional restriction. The rst term is positive and captures the direct effect of the increase in c holding the number of condoned violations constant. The second term captures the indirect effect of an increase in c through the induced reduction in the number of condoned violations and works in the opposite direction.

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