DP12584 Interlinked Firms and the Consequences of Piecemeal Regulation

Author(s): Christopher Hansman, Jonas Hjort, Gianmarco León
Publication Date: January 2018
Keyword(s): air pollution, Coasian solutions, externalities, Industrial regulations
JEL(s): D2, I1, L5, O1
Programme Areas: Public Economics, Industrial Organization, Development Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12584

Industrial regulations are typically designed with a particular policy objective and set of firms in mind. When input-output linkages connect firms across sectors, such "piecemeal" regulations may worsen externalities elsewhere in the economy. Using daily administrative and survey data, we show that in Peru's industrial fishing sector, the world's largest, air pollution from downstream (fishmeal) manufacturing plants caused 55,000 additional respiratory hospital admissions per year as a consequence of the introduction of individual property rights (over fish) upstream. The upstream regulatory change removed suppliers' incentive to "race" for the resource and enabled market share to move from inefficient to efficient downstream firms. As a result, the reform spread downstream production out across time, as predicted by a conceptual framework of vertically connected sectors. We show evidence consistent with the hypothesis that longer periods of moderate air polluting production can be worse for health than concentrating a similar amount of production in shorter periods. Our findings demonstrate the risks of piecemeal regulatory design in interlinked economies.