Environmental regulations and allocative efficiency: application to coal-to-gas substitution in the U.S. electricity sector

Abstract

The environmental economics literature has for a long time been occupied with the relationships between environmental regulations, technical efficiency, and productivity growth. This paper extends this discussion by taking up environmental regulations’ implications for allocative efficiency. It establishes a model framework that allows disentangling managerial and regulatory induced allocative efficiencies, and utilizes Data Envelopment Analysis to a sample of 67 coal-to-gas substituting power plants observed from 2002 to 2008 to calculate Nerlovian profit efficiencies and their technical and allocative efficiency components. The empirical results illustrate that failing to control for environmental regulations leads to overestimation of managerial allocative efficiencies by ignoring compliance costs. Marginal abatement cost estimates that are in line with allowance prices for NOx and SO2 are further obtained.