Environmental and Resource Economics 24: 103119, 2003.

103
2003 Kluwer Academic Publishers. Printed in the Netherlands.

A Procedure for Negotiating Pollution Reduction

under Information Asymmetry
Surface Water Quality Case

PETR AUER, ANTONN DVORK,

ALE LISA and PETR FIALA
Department of Environmental Economics, University of Economics, W. Churchilla 4, 130 67
Prague 3, Czech Republic ( author for correspondence, e-mail: sauer@vse.cz)

Accepted 24 June 2002

Abstract. This paper considers an alternative approach to surface water quality management when
society is faced with the need to reduce water pollution in a region with a complicated regulatory
environment. The paper is focused on a specific kind of negotiation between polluters and an
authority, leading to resolution of the problem when there is the information asymmetry between
the authority and the polluters, i.e., the true pollution abatement costs are known to the polluters
only. This paper reports a laboratory experimental case prepared at the Department of Environmental
Economics, the University of Economics in Prague. The comparison with theoretical computed first-
best results under conditions of full information is included. Political and economic aspects of the
suggested approach are also discussed.

Key words: economic laboratory experiments, environmental policy, information asymmetry,

negotiation, water quality

JEL classification: Q25, C72, C78, C92, C91

Introduction
This paper considers an alternative approach to surface water quality management
when society is faced with the need to reduce water pollution in a region with
a complicated regulatory environment. The paper is focused on a specific kind of
negotiation between polluters and an authority, leading to a solution of the problem.
Regulatory authorities are usually unfamiliar with the full range of microeco-
nomic parameters of pollution reduction solutions: environmental damage costs
are not well known, and the true abatement costs (pollution reduction costs) are
known to polluters only, making it a typical case of asymmetric information. This
is one reason why it is practically impossible to achieve a so-called first-best
solution to the pollution reduction problem. The information asymmetry between
the authority and polluters calls for an alternative approach that can be achieved by
negotiation among the parties to reach a third-best solution to the problem.
The approach is focused on interactions among interest groups and regulatory
authorities. Specifically, it involves the bargaining process and shows how special
104 PETR AUER ET AL.

interests can be used to serve pollution control objectives. Potential practical appli-
cations of the suggested approach are also shortly discussed. Traditional economic
tools are used in the suggested approach. Prices of quality of water have a form of
environmental charge and/or a form of financial contribution as one result of the
negotiation process. External financial sources, e.g., investment loans provided by
some banks, could be used as a powerful incentive in the process.
The recommended approach was tested through the use of laboratory economic
experiments based on both ideal and real (field) data. The experiment tested
the hypothesis whether the institution of negotiation, combined with economic
instruments of environmental policy, might work in this field, and whether it
is reasonable to continue laboratory experiments before an implementation of
the scheme in practice. The experimental results show that the approach is well
suited to address surface water pollution issues. This paper reports a case exper-
iment prepared at the Department of Environmental Economics, University of
Economics in Prague. A comparison with theoretical computed first-best results
under conditions of full information is also included.
Laboratory experiments allow testing of proposed reforms/institutions with
relatively low social cost. Of course, laboratory experimenting has its weak points.
For example, it might not be possible to simulate real world situations in one
experimental set-up, or the experimental design might not reveal the true beha-
viour of the participants. However, experiments can be replicated and improved
and it is possible to control both the value/cost environment of the experiments and
the set of rules for the participants behaviour and investigate the behaviour. The
most important advantage of experimental economics is that the consequences for
society are very low compared to trial and error implementation. If the suggested
institution failed to work in a relatively simple experiment, there would be little
reason to expect that it would work in practice.

Methodological Context of the Suggested Approach

Several approaches to solving pollution reduction problems that are based on or
lead to some kind of pricing of environmental goods have been developed in the
four-decade history of environmental economics. Several of these approaches serve
as a theoretical basis for the creation of systems of practical environmental policies.
They include, among others, the approach known as the Pigovian tax (Pigou 1932)
that was applied later by many authors; the Baumol and Oates solution to environ-
mental pricing based on arbitrary setting of environmental targets (Baumol and
Oates 1971); pollution permit trading extensively addressed by Tietenberg (Tieten-
berg 1980), and the well-known Coases approach based on negotiation between
polluters and polutees (Coase 1960).
The core of our approach is the negotiating process between environmental
(regulatory) authorities and polluters. The fact that the authority is supposed
to use economic tools of environmental policy is another important element of
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 105

the concept. There are two main groups of economic tools that are used in the
approach. The first one includes various types of environmental payments (charges,
fees), which both send signals to polluters and create revenues that are allocated to
an environmental protection fund. Financial contributions from the fund (subsidies,
loans, etc.) that are used to support environmentally friendly behaviour (projects)
of polluters are the second set of tools. It is important to stress that these two kinds
of tools are linked up in a system. The economic instruments of both payments
and financial contributions represent a special price of achieving a target quality
of a natural resource. Some additional economic tools include negative induce-
ments such as penalties and other sanctions associated with non-compliance with
agreements.
The payments must be linked with a concrete and well measurable object of
charge. Most often emissions per unit of time serve as the basis for these payments.
The payments could also be derived from other sources such as the amount of
environmentally non-friendly goods that are produced or sold, or from the amount
of hazardous materials or energy used in production. What is important to note
for our approach is that the final rate (for instance payments per unit of pollution)
and the total amount of payments (revenue) can be endogenously determined, as
another outcome of the negotiation process between the polluters and the authority.
Payments play a prominent role in the approach. The amount of these payments
can be approximately proportional to the amount of the environmental damage
caused by the polluters (it corresponds to a polluter pays principle), but it does not
necessarily quantify these damages. The sum of the revenues from the payments
can create the amount that is necessary for adequate financial support of the pollu-
tion reduction goals in a region (it can correspond to a self-financing principle).
The mix of both types of tools, payments and financial contributions, and their
value, guarantees that the economic interests of a group of polluters will work in
the direction of reducing pollution to a desirable level. More importantly, in this
group of polluters there are polluters that can reduce pollution with the lowest
abatement costs.
Dynamic variants, especially those where returnable (revolving) forms of the
financial contributions from the fund (for instance investment loans) are used, are
the most useful forms of the approach. An external source of loans can also be built
into the process (e.g., loans provided by banks).
The distribution of financial support by the authority from the fund is very
important. The most important aspect is the introduction of the principle of maxim-
isation of positive environmental effects per unit of the support. A different set of
environmental indicators for charging and for setting priorities of environmental
protection solutions in the region can be used. Public interest in this is an important
challenge. Participation of NGOs in the negotiation process is desirable and can be
part of the application.
The creation and use of special models is proposed for decision-support in
the process of negotiation of both polluters and authorities. Modified methods for
106 PETR AUER ET AL.

assessing efficiency of capital investments and a quantification of net costs of abate-

ment are the bases of the models for decision-support of the polluters. On the other
hand, expert methods can be used for designing the models for decision-making of
the authorities.
The simplified negotiation procedure could be described as follows: In the first
step the authority assesses the initial rate(s) of environmental payment per one
unit(s) of pollution. This serves as the first type of economic information available
to polluters and enables polluters to quantify their (confidential) amounts of net
abatement cost (auer 1986). Polluters transmit their offers in terms of pollution
reduction and the required amount of the financial support from the fund. The space
for bids of single polluters is theoretically given by an interval. The lower limit is
based on a subjective criterion value of efficiency of the given project of the given
subject-polluter resulting in a minimum subsidy required to justify the investment
in our case (see later). The upper limit is unbounded. But the polluter must consider
the fact (in his strategy) that if his bid is too high, he will be out of the game since
the sources in the fund are limited and the priority is given to the bids with a
higher degree of cost-effectiveness. The authority ranks the proposals according
to the principle of maximisation of the ecological effect of the offered solutions
per one unit of resources required from the fund. In the second step, information
about the authoritys bid(s), in terms of the amount of financial contribution to
pollution reduction is then communicated to polluters. It serves as further economic
information for polluters decision making about their bids.
This procedure continues for several rounds until an efficient third-best
solution is achieved. Discussions about macroeconomic, ecological and social
consequences of the received results can follow. The negotiation process can be
repeated if necessary.
An official final binding agreement between the polluters and the authority
seems to be an important tool. Such an agreement can contain statements about
the realisation and implementation of environmental protection project(s), pollu-
tion reduction, or quotas on pollution within concrete scheduled time horizons,
penalties paid in the case of non-compliance on the part of polluters and financial
and/or other kinds of support from the authority.

A Case Experiment for the Czech River

CASE DESCRIPTION

An ideal case was developed on the basis of the Czech River pollution and
was called Ceska River. The case draws on data taken especially from experts
working on water pollution prevention projects and from the State Environmental
Fund of the Czech Republic.
The Ceska River is a substantially polluted river. This is especially the case
during summer periods, when limits of emissions for major pollutants are substan-
tially exceeded by major polluters. Total emissions of pollutants are as follows:
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 107
Table I. Major polluters

Polluter Subject characteristics Amount of pollution

(recalculated units/year)

A Textile company 30,760

B Stone manufacturing company 5,760
C Textile company 7,750
D Pigments manufacturing company 4,500
E Heating station 14
F Photo company 50
G Metal surface 10,800
Remanufacturing company
H Textile company 102,560
I Food production company 365,200
J Food production company 157,890
K Waterworks company 176,750
L Municipality I 54,605
M Municipality II 99,500
N Municipality III 105,250
O Municipality IV 43,790

Total 1,165,108

3,700 tons per year of COD (Chemical Oxygen Demand); 790 tons per year of
dissolved substances; 1,320 tons per year of insolved substances; 18 tons per year
of phosphorus; and 140 tons per year of nitrogen. Recalculated emissions reach
approximately 1,454,000 units per year. (The recalculated emissions were used for
a simplification. They reflect harmfulness of the pollution both to human health and
to ecosystems using so-called coefficients of harmfulness for the multiplication
of the amounts of single pollutants. In this case, they do not reflect territorial
aspects of the pollution.) There are 15 major polluters (companies and municip-
alities) that are responsible for approximately 80% of the pollution in the region
(see Table I).
Environmental fees for all pollutants listed above have been introduced (see
Table II). Fee rates are based on Czech environmental laws on water pollution (Act
No. 58/1998 Coll.).
Every polluter could have an investment project aimed at reducing the amount
of pollutants discharged into the River. Every particular project has specific impacts
on the economic activities of the polluter. Decisions of polluting companies on
capital investment effectiveness are mostly based on comparisons between the level
of payback period indicators and the calculated payback period of a particular
project. The payback period is calculated on the basis of cash flow and capital
investments cost. In some cases the cash flow change (resulting from project
108 PETR AUER ET AL.

Table II. Environmental fees paid by surface water polluters

Polluting substance Environmental fees

(CZK per 1 kg)

COD 16
Dissolved substances 0.5
Insolved substances 2
Phosphor 70
Nitrogen 30

Note: Fee values are in Czech Crowns (36 CZK 1 USD).

implementation) might be positive, and in some, negative. Willingness of polluting

municipalities to invest in projects of this kind is usually based on and/or results
from previous political negotiations. Initial reaction of polluters demonstrates that
in many cases projects with environmentally positive effects, even those having
some positive economic impact, do not bring about economic effects which would
stimulate companies or municipalities to implement them (an enabling mechanism
by the Ministry of Environment, see the Annex to this paper).
The environmental objective for the Ceska River is to reduce pollution from all
sources at least by about one third and to reduce pollution from the main sources
by one half, both in terms of recalculated emission units and individual pollutant
levels.

EXPERIMENTAL DESIGN

Fifteen secondary business schoolteachers (attending summer school in August

1998) were used as subjects in the experiment. They played the roles of
managers both of polluting companies and municipalities. Three subjects (univer-
sity researchers) played the role of representatives of the local authority.

The Polluters set of materials. A set of materials for participants playing the role
of polluters included the following items:
(a) A case description, including description of the procedure of the experiment
(i.e., a set of rules for behaviour in the experiment) and including formulas
for a quantification of net costs of abatement (= minimal capital investment
subsidies required from the fund in the experiment). In this simple case,
payback period of capital investment costs was taken as the criteria for effi-
ciency of the water pollution reduction projects. The payback period was
quantified very simply as a quotient of the capital investment costs and a total
annual average change of cash flow of the polluter, which would be caused by
the project.
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 109

(b) Information about the polluter and his solution (water pollution reduc-
tion project). Most of this information (especially the data that creates the
value/cost environment of the experiment) has a confidential character1 and
it was distributed to individual polluters only. This material contains informa-
tion as follows: name of the firm, type of activity (production etc.), impact
on the environment (annual amount of pollution), basic (economic) data about
the polluter, environmental effects of the environmental protection project (i.e.,
water pollution reduction that is possible to offer in the process of negotiation),
economic parameters of the project (capital investment costs, change of cash
flow, environmental fees reduction, payback period of the capital investment
cost, and maximal payback period to be required in the experiment). To avoid
critical numerical mistakes of participants, which probably never would occur
in practice (like mistakes caused just by miss-setting of formulae in a limited
time reserved for the experiment), the participants playing the role of polluters
were individually provided with the correct calculation of the minimal financial
support they should require from the authority (i.e., minimum subsidy required
to justify the investment). They were asked to compare their calculations with
that.
(c) Communication sheet prepared for the communication between the polluter
and the authority in the process of negotiation. The sheet contains two pieces
of information: (1) Water pollution reduction offered by the polluter, and (2)
Subsidy required by the polluter from the environmental protection fund.

The authority set of materials. A set of materials for participants playing the role
of the authority consisted of the following: (a) The same description of the case as
was included into the polluters set of materials. (b) An example (demo-version)
of the confidential information available to a typical polluter and a copy of the
polluter-authority communication sheet. (c) A sheet for recording the authoritys
side of the history of the negotiation. (d) A table containing data for avoiding
critical numerical mistakes of laboratory experiment participants, which probably
never would occur in practice and which should be used only in the case that some
participant-polluter needs a consultation. It was not the case in our experiment. (e)
A software for the negotiation. It was a simple PC spreadsheet for support of the
authoritys decision making.
Real money to increase the interest of participants in rational behaviour during
the experiment was not introduced in this case because of a shortage of resources
reserved for the experiment.

PROCEDURE OF THE EXPERIMENT

The process of negotiation can be generally characterised as an extensive form

game with two types of players (authority and polluters), who alternate their
proposals. The first type of player (authority) gives proposals of unit support and
110 PETR AUER ET AL.

the second type of players (polluters) gives applications for support. The altern-
ation of proposal and counter-proposals depends on previous steps of the game.
Both types of players have continuous sets of strategies. This type of game is very
difficult to transform into trivial finite normal form game and apply Nash equilib-
rium (Nash 1951) solution. The specific process of negotiation can be described as
follows.
The particular experiment considered a system in which an environmental
protection authority A collects payments from environmental polluting units
and creates an environmental fund of the amount F. The fund was used as a
source of financial subsidy support of polluters environmental protection capital
investments.
The total level of pollution (which is for simplicity calculated as recalculated
units of emissions) depends on the following factors: the type of pollutants, the
amount of emissions, and the level of harm to public health and to the environment.
The system consists of 15 polluters: P1 , P2 , . . . , P15 . The levels of pollution are
denoted by zij , with i = 1, 2, . . . , 15 being the polluters, and j = 1, 2,. . . , 5 being
the pollutants. The authority knows both the total level of pollution and amounts of
polluters emissions. All polluters have two decision alternatives: either to realise
the environmental capital investment project (in our case, one project is available
for each of them) or to continue the current situation, i.e., to continue polluting.
The realisation of the projects causes positive environmental effects e1 , e2 , . . . , e15
(i.e., recalculated emission reductions, which are offered to the authority in the
process of negotiation) and needs capital investments I1 , I2 , . . . , I15 . Polluters could
have or could not have economic interests in the realisation of the projects. All
polluters can request the subsidy support from the authority A. The authority has no
information about the environmental projects (especially about the economic side
of them and has no possibility of computing minimal capital investment subsidies
to be required from the fund in the experiment (= minimum subsidies required to
justify the investments) D1 , D2 , . . . , D15 .
The problem is solved over several time periods. The vector of payments (fees)
p per unit of pollution is supposed to be constant within one negotiation process
(but could be changed for a new negotiation process). In our case, the payments
were taken from environmental laws of the country. In the time period t polluters
Pi request the subsidy support R(t,r) i , i = 1, 2, . . . , 15. In the time period t, there
are realised r negotiation rounds. In the rounds, the authority A states and proposes
a unit of the subsidy support per unit reduction of recalculated emissions d(t,r) .
Polluters Pi request the subsidy Support R(t,r) i , i = 1, 2, . . . , 15, based on their
computations. The minimum subsidy required to justify the investment Di and
requested subsidy supports in time periods and rounds R(t,r) i can be different. But
the requested subsidy support must be greater or equal to the minimum subsidy
required to justify the investment.
One goal is to achieve the best distribution of subsidy support from the fund F
to polluters. The criterion of that is to minimise the subsidy per one unit of positive
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 111

environmental effect (or to maximise positive environmental effect per one unit of
subsidy), given a requirement for pollution reduction of the amount E in the region.
The negotiation process is described in the following steps:
(a) To start the negotiation process let us set time period t = 1.
(b) The authority A states the unit payments pj (which were taken from the
Czech environmental law and they were fixed for all rounds), for pollutants
j = 1, 2, . . . , 5, and computes the amount of the fund in the time period t = 1
using Eq. (1)

15

5
F (1) = pj zij(1) (1)
i=1 j =1

(c) Polluters Pi , compute the minimum subsidy required to justify the invest-
ment Di . The minimum subsidy required depends on the unit payment pj and
economic parameters of the project.2
(d) In the time period t a negotiation round r is realised. Polluters propose environ-
mental projects. Polluters give information about the reduction of recalculated
pollution ei and request the subsidy support R(t,r)
i .
(e) The authority evaluates information from polluters (ei , R(t,r)
i ), i = 1, 2, . . . , 15,
and sorts projects by the requested subsidy support per unit of environmental
effect
(t,r) (t,r) (t,r)
R[1] R[2] R[15]
... (2)
e[1] e[2] e[15]
where the brackets indicate positions in sequence. Thus [i] = j means that
(t,r)
R
polluter j is in position i in the sequence of values e[i][i] .
(f) It is possible to subsidize only some polluters (scarcity of the resources in the
fund). It is assumed that the last supported polluter is in place k in the above
sequence. Then (3) holds
[k]

(t,r)
R[i] F (t ) (3)
[i]=[1]

We denote the rest of the unused amount of the fund S (there is not a possibility
to provide only a part of the subsidy required by the last polluter the step-wise
function problem) in the time period t as
[k]

(t,r)
S (t ) = F (t ) R[i] (4)
[i]=[1]

The rest of unused sources in the time period t could be transferred to the next
time period t + 1.
112 PETR AUER ET AL.

The authority sets and proposes the unit subsidy support d(t,r) , which is the
same for all polluters. (For alternative strategies used in the suggested negoti-
ation process see auer et al. 1998). Polluters evaluate the subsidy supports. If
it is the last round of negotiations in the time period t, the process proceeds to
the step g. If it is not the last round, than we set r = r + 1 and proceed to the
step (d).
(g) A discussion of the proposed solution from the point of view of the entire
region takes place. The proposed solution is accepted from an environmental
point of view if the environmental target E is met, i.e., if (5) holds
[k]


e[i] E. (5)
[i]=[1]

If the proposed solution is accepted from the environmental point of view the
agreements can be concluded and the negotiation process ends. A solution
meeting (5) may not exist; i.e., in cases where the negotiated result is not
accepted from an environmental point of view, it will continue from step (a) for
additional time period(s) until the environmental targets are met. Alternatively,
the whole negotiation process could also be repeated with modified payments.
This was not the case in the experiment reported here since the environmental
target was achieved in the first time period.

RESULTS OF THE LABORATORY EXPERIMENT

Prior to presenting the experimental results we computed a first-best solution that

assumes full information. Both the computed and the experimental results are
presented in Table III. An approach (negotiation strategy of the authority) leading
to establishing the equilibrium level of the unit subsidy u, was used in both cases.
The financial support provided in the experiment was based on final requests of the
successful polluters.
A positive environmental agreement was achieved between the authority and
polluters J, B, I, K, C and G at the end of the third round of the first time-period of
the experimental negotiation process. An annual pollution reduction of the Ceska
River in the amount of 535,825 recalculated units was achieved. The pollution
reduction represents about 37% of the total pollution of the River and approxi-
mately 46% of the pollution caused by the polluters. The total pollution reduction
consists of COD pollution reduction by 1,396 t/year, dissolved substances by
225 t/year, insolved substances by 318 t/year, phosphorus by 9 t/year and nitrogen
by 110 t/year.
Six environmental protection projects were supported (subsidised) by the
environmental protection fund governed by the authority. A total amount of 54,191
thousand CZK revenues from environmental fees, was collected by the fund within
the time period of the experiment. An average negotiated subsidy per unit of pollu-
tion reduction was 0.102 thousand CZK. The total amount of subsidies 54,780
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 113
Table III. Comparison of computed and experimental results (in thousand CZK)

Experimental results Computed results

Subsidised Pollution Subsidies Subsidy Subsidised Pollution Subsidies
Polluters reduction provided per unit polluters reduction provided
(rec.units) (negotiated) (rec.units)

J 151,975 12,000 0.079 C 1,440 150

B 5,760 500 0.087 G 7,200 749
I 280,700 28,000 0.100 I 280,700 29,193
K 88,750 12,030 0.135 J 151,975 15,805
C 1,440 250 0.174 B 5,760 599
G 7,200 2,000 0.278 N 89,448 9,303

TOTAL 535,825 54,780 0.102 TOTAL 536,523 55,799

Note: Computed subsidy was CZK 0.104 thousand for marginal (closing) unit.

thousand CZK was distributed in order to stimulate polluters to realise their

environmental protection projects. The difference between the resources available
and their use was very small both in the case of computed (1.5 million CZK, which
comprises 2.7% of the fund) and negotiated (589 thousand CZK, which comprises
1.1% of the fund) solutions. This small difference may be covered by external
sources.
Comparing the list of polluters in the computed and experimental results, it is
visible that it is almost, but not quite the same. The polluter N chose too strong
negotiation strategy and was out of the game at the end of the negotiation process.
He opened the space for the polluter K.
Another pilot laboratory experiment was done with university students of
Environmental Economics and policy specialisation at the University of Economics
in Prague. Although these subjects were softer negotiators than the teachers, the
results achieved were similar. Agreements were achieved with companies I, B, J, N,
K and G, the pollution reduction was 623,833 units, an average negotiated subsidy
of pollution reduction per unit was 0.084 thousand CZK and the total amount
of sources spent from the fund was 52,650 thousand CZK. Also here, the list of
polluters in the computed and experimental results is not the same. The student
representing polluter C created space for polluter K.

PRELIMINARY CONCLUSION FROM THE EXPERIMENTS

These results could already be used to support a planning process of environmental

policy. They (potentially) could also be compared with the results obtained via
simulation methods, such as the Monte Carlo approach (see Cueva and Lauria
2000). However, the Monte Carlo simulation that was designed to address the
problem of lack of information of certain parameters is more suitable to deal with
114 PETR AUER ET AL.

the public than with private agents. In the case addressed in this paper, as in many
other similar cases, the transaction costs (estimation of parameters) of applying a
simulation approach may be very high. In such cases experimental approaches are
more efficient and allow testing of various options at relatively low cost (see Easter
et al. 1998).
But the most important result of the experiment is a step toward a verification
of the hypothesis of a possibility to establish the suggested negotiation approach as
a new institution for water quality management in practice.
It might have sense to prepare cases with different shapes of the curve of the
minimum (investment) subsidy per unit of reduced pollution to justify the invest-
ment (for the flat and for the steep ones) and test the robustness of the results
in laboratory experiments. Hypothetically, the results would be more robust if
the curve is steeper and vice versa. But even if the results are not so robust (in
terms of the list of involved polluters) in the case with the flat curve, still the
results should be relatively cost-effective. The same problems could be tested when
formulating alternative targets of environmental policy for the experiments under
different segments of the (hyperbolic) curve, i.e., for different slopes of tangents
in different points of the curve. The second approach is more usual for cases using
data from practice.
The results of our experiment are rather special, particularly because the
polluters enter the negotiation process with only one investment option (project).
The situation could be more complex. Let us briefly discuss some of the possi-
bilities. The polluters could have several alternative options how to contribute to
solving the given problem. In this case they could select the most efficient one and
enter the negotiation. The polluters (understood as independent economic subjects)
could offer several (non-alternative) projects and try to negotiate support for all of
them.
The options of single polluters also could depend (technically, economically) on
solutions of the other polluters. Then two (trees of) situations could be discussed.
The first ones are non-cooperative cases when the polluters do not cooperate
on creating some common solution. In this case the problem has a character of
solving the Nash equilibrium point in a non-cooperative game. The second ones
are cooperative cases when the polluters cooperate on creating some common
solution(s). In this case the problem has characteristics of searching for a nucleus
of a cooperative game. The polluters create coalitions and divide the synergistic
effects of the cooperation. This common solution could be more efficient from
both economic and environmental points of view than isolated solutions realised
by single polluters.
Creating a comprehensive tree of hypothetical possibilities, scholarly discussing
and step-by-step testing them in the experiments could bring interesting results on
how it could work out. But for the future work it seems to be more fruitful to
identify various practical cases in environmental protection and analyse them from
the points of view of the game theory, conflict resolution theories, economics and
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 115

law, concerning their appropriateness for negotiating and concluding negotiated

voluntary agreements (for concrete suggestions see auer et al. 2001).
For better testing of puzzles in behaviour of subjects, it would be desirable
to let practitioner managers participate as experimental subjects. Such experiments
could be prepared as a part of some training workshop where the managers are
instructed concerning alternative environmental policy tools for solving the same
case. Discussions after such experiments also generate important information.
The case showed that the approach based on a mix of a negotiation between an
authority and polluters and using economic tools of environmental policy seems
to be promising for solving some of the complicated environmental pollution
problems.
More advanced political economy discussions about practical concept imple-
mentations should be the next step of the research together with preparing
more practical cases and testing possible behaviour of participants in laboratory
economic experiments.

Brief Practical Application Discussion

Several application possibilities of the approach could be discussed and tested
in laboratory experiments. The first application takes place under circumstances
where the agreement is achieved in the process of a voluntary negotiation between
polluters and regulators (like a state environmental protection fund) when the latter
does not know much about the microeconomic data about polluters solutions.3
This is the case that was described in the previous section.
In some cases the authority need not be a governmental institution. A special
institution could be created by parties to the negotiations and could serve more
as a mediator than a powerful bureaucratic subject. It is also possible to consider
establishing an environmental protection fund as an organisation that is privately
owned by polluters to take part in the negotiation.
Hypothetically, applications within single corporations are also possible espe-
cially where there are more sources of pollution that are controlled by different
organisational units within a single firm. The concept can serve as a tool in the
situation when the corporation is faced with the goal of reducing pollution from
its sources by a given total amount. It could work for instance in a case when the
corporation wants to conclude a voluntary unilateral commitment or to sell part of
their polluting rights. The approach could be useful for solving the principal-agents
problem where the managers and owners utility functions are different. Managers
of the organisational units would negotiate with the top management of the whole
corporation.
Practical applications of the approach are limited in the case where pollution
limits are introduced. This is the similar problem encountered with economic tools
of environmental policy in general.
116 PETR AUER ET AL.

In the age of environmental policy tool mixes, the approach could be discussed
as a tool for initial distributions of pollution rights to be later traded within a system
of tradable pollution permits (for an example of trading with the water quality see
Yandle 1999).
The interests of polluters in this approach seem to be a critical problem. What
would attract them to take part in this kind of solution? Some of them can be
attracted by the possibility of having a chance to receive the financial contribution,
which can be very attractive for some of them because of the surplus over net costs
of abatement. Some of them may also feel that they have a chance to promote better
contacts with authorities. On the other side, there are those subjects, which know
that, most likely, they will (only) pay without a chance of receiving additional
sources. It is not always true in the case where some environmental charges are
already introduced (like it is in the Czech Republic and in some other countries). In
this case polluters that take part in the negotiation process more likely will benefit
from it than suffer a loss. Taking part in some application of the negotiation gives
to polluters a chance to be better prepared for lobbying in the process of preparing
environmental laws because they can learn more about their interests in the field
during a preparation and running the negotiation.
An advantage of the approach seems to be associated with participation of stake-
holders. Non-governmental organisations (NGOs) and other stakeholders could
also play an important role in the negotiation process. They could participate in
preparing the coefficients of harmfulness or they could collaborate with the
authority on ranking the polluters proposals.
The approach is able to stimulate research and development in the field of
environmental protection. It could stimulate searching for already existing tech-
nical solutions on the one hand and create a demand for developing new solutions
for environmental protection on the other hand.
The advantages of the approach might be promoted by institutions like major
banks. Loans in connection with the concept could speed up the process of finding
solutions to environmental problems in a given area and promote cost-effective
allocation of resources together with sources from the loan. In addition, environ-
mental charges reduce the risk of not paying back the loans to a bank. This risk
aversion could lead to better conditions for providing the loans. The loans also
could contribute to other (technical) innovations in a given economy and support
positive structural change in a country or in a region.

Concluding Remarks

An approach based on a mix of negotiation between an authority and polluters

and use of economic tools of environmental policy offers promising solutions to
some of the complicated environmental pollution problems, including water pollu-
tion reduction. The fact that no or very limited microeconomic information about
A PROCEDURE FOR NEGOTIATING POLLUTION REDUCTION 117

pollution reduction solutions is available to the regulatory authorities constitutes

one of the advantages of this approach.
The approach was tested several times as a laboratory economic experiment
(experimental game) in a university course of Environmental Economics and
Policy at the Department of Environmental Economics, University of Economics,
Prague. The cases posed the situation of a region where some pollution reduction
was necessary. A satisfactory solution was always achieved in the experiments.
Results of experiments with a water pollution reduction objective are shown in
the case described above. New experiments are being prepared. These experi-
ments concern practical cases with more aspects of the environment, particularly
water pollution problems. They should enable verification of other variants of
the concepts techniques and promote deep discussions on environmental policy
aspects of the practical implementation of the approach. It is our goal, after a
brief testing of the new cases with university students, to invite actual managers
to participate in the new experiments.
Because the concept as well as the negotiation process itself are politically and
ideologically neutral (which might not be true, of course, about the contents of
the discussions) they represent good tools for efficient implementation of goals
in environmental pollution improvements, including the identification of problem
areas. The approach could enable various subjects (companies, state authorities,
banks, political parties, NGOs) to realise their aims in more efficient ways, as they
can overcome various political and other short-term interests.

Notes
1. Confidentiality has two meanings here. First, it means that there is an information asymmetry
between the authority and the polluters; second, these data were provided based on a confiden-
tiality agreement with some Czech companies and they couldnt be published for this reason in
the chapter, although it would be very useful.
2. The minimum subsidy required to justify the investment Di for polluter Pi was calculated as
Di = Ii P Bimax dCFi . The change of cash flow dCFi includes a change of net profit, which
reflects the impact of reduced payments for the pollution in the case that the investment project
is realised and a change of capital investment depreciation. The maximally acceptable payback
period P Bimax of capital investment Ii was set arbitrarily and reflects standard decision-making
about similar capital investment. For alternative approaches to the calculations of the minimum
subsidies required to justify the investments see Dvork (1993).
3. Although it is a very strong precondition that will be only rarely accomplished in practice,
it is possible that the situation could arise where microeconomic information about solutions
is available to the authority. Independent consulting firms are sometimes able to provide such
information. Firms of this sort exist and create environmental engineering databases, including
items concerning costs of environmental protection solutions. In this case it is possible to think
about several computations on the model for various values of exogenous variables. It could
serve for an appraisal of environmental pollution charges in combination with some principles
of financial support of environmental investments from public financial sources. This compu-
tation could be made on a representative sample of solutions where there is some possibility
to quantify environmental protection costs associated with these solutions. The model enables
(because of the structure of information) the verification of some additional approaches and tools
118 PETR AUER ET AL.

of environmental policy like pollution permit trading. In this case it is, for instance, possible to
derive a supply curve on pollution permits in a region. Availability of at least limited information
about the costs of environmental protection solutions can also significantly help with setting the
(initial) bid by the authority in the negotiation process.
There is one more problem with generating quality microeconomic information about the
environmental protection projects. Corporations typically encounter two major obstacles for
generating and providing environmental information. The first obstacle is that many companies
do not want to make this type of information publicly available. The proposed negotiation
approach enables to overcome this problem because the microeconomic information can be
fruitfully used without requiring that the data be made public. The second problem, based
on the authors experience from the Czech Republic, is that many companies do not generate
environmental information because in the absence of an environmental management system this
type of data collection is expensive.

Appendix 1: Rules for Environmental Projects

The Ministry of the Environment has made it possible to realise projects on regional
(decentralised) levels of environmental policies. The rules for such projects are as follows:
It is possible to disregard emission limits for particular pollutants declared by a
prepared law;
It is allowed not to transfer emission fees to the central environmental protection
fund;
It is possible to solve an environmental situation by voluntary negotiation between
major polluters on the part of a river and a local authority. The water emission fees
might be transferred into a local environmental fund and used to support projects
designed to lower water pollution in a given area (part of the river);
The project will ensure at least the same level of water pollution in a given area (part
of the river) as would have resulted from regulatory fiat. The results will be evaluated
on the basis of pollutants taking into account the parameters of the project.
The project assumes that a binding agreement between the central environmental
protection authority and the local authority exists. This agreement maintains that: (1) if
the level of pollution in a given area (part of the river) is decreased to target amounts, the
emission limits and centrally set environmental fees for water pollution will not be applied
in that given area for 10 years. (2) if the agreement between the polluters and the authority
do not come into existence within the declared time period (12 months), the limits and
fees will be put into operation. A penalty of 15% of the fee paid past the due date might
be added.

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