Health, Safety And Environmental Risks Regulation

Health, Safety And Environmental Risks Regulation

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Health, Safety and Environmental Risks Regulation

Introduction

There was a wave of health, safety and environmental risk regulation in the early 1970s. New regulatory agencies were established by the United States government with a wide regulatory responsibility on matters concerning risk and environmental policy (Viscusi, 2006). Some of the new federal regulatory bodies established by the government are; Occupation Safety and Health Administration (OSHA), Environment Protection Agency (EPA) and Consumer Product Safety Commission (CPSC) among other agencies. The federal government regulations on environment and safety are aimed at protecting people against harm. These regulations have yielded numerous benefits. However, they carry tremendous costs to implement and maintain. Nonetheless, despite this fact there is a wide gap between those advocating for the maximization of the scarce resources and those who want this put in practice in enforcing U.S regulatory programs (Calandrillo, 2001).

The agencies established by the government addressed issues concerning risks facing people such as morbidity and mortality risks. Along with this, others concentrated on hazards to natural resources that have a direct effect on people. These agencies were not created as a result of unprecedented increase in the risk levels of the society. According to the national safety authority individual mortality risks of all kinds had been declining steadily throughout the twentieth century and this continues to be observed (Viscusi, 2006). However, this observation was not observed in the environment risks. Environmental pollutant had been observed to increase until environmental regulations and agencies were created (Viscusi, 2006).

According to Viscusi (2006), courts roles in respect to risks were observed to increase after the establishment of regulatory agencies and risk regulations. Viscusi observes that liability insurance premiums increased tremendously leading to calls of a liability crisis in mid-1980s. The opposing argument was that the rise in the premium rates is as a result of normal ebb as well as flow of insurance industry. There have been observed a synergistic relationship between regulations and litigation over the years in a number of industries. This has been observed mostly in the cigarette industry. This relationship between litigation and regulation has evoked quite a controversy. However, the general agreement is that health, safety and environmental regulation should exist. Nonetheless the main question is over the regulatory action targets, the necessary intervention modes and how strict should these regulations be. Therefore there is need to have a balance on the reduction of risk as well as cost and how to maximize the welfare of the society. There is a conflict on how to achieve maximum social welfare at minimum costs and efficient regulations.

Market performance is a key determinant of the necessary interventions that are applied by the government through regulations and tort liability. This is a result of market failures that necessitates these interventions. These interventions are assessed using the model of rational individual choice. This is how people make decisions in regard to markets. In case the markets function perfectly and choices are fully rational, this provides a very important reference point on what to tradeoff between cost and risk. It is also observed that regulatory policies are not always efficient. Therefore it is always good to conduct a Risk – risk analysis. This is where the risk increasing aspect of a risk is weighed in contrast to the risk reduction outcomes of the regulation (Viscusi & Gayer, 2002).

The main aim of this thesis is; to identify sources of market failure of regulations on environment, health and safety, to identify decision procedures for regulatory measures and to identify how the government implements these regulations. The first topic of this thesis covers introduction, which encompasses issues concerning regulation, aims of this thesis and structure of the thesis. Chapter two is comprised of sources of market failure which includes imperfect perception of risk, irrational behavior and addiction, externalities and modes of intervention. Chapter three discusses decision procedures necessary for regulatory measures. This includes cost benefit analysis, risk analysis as well as commonalities and differences. Chapter four consists of implementation and government regulations, which includes enforcement and performance of government regulations, implementation difficulties and reform. Chapter five consists of conclusions.

Sources of market failure

imperfect perfect risk

2.1.1 Biases in Risk Beliefs

The term market failure is used to define problems that cannot be solved by the mere existence of a free market. If people don’t understand the risks that are involved there is high probability that individual choice they are going to display biasness in accordance to their risk beliefs. This is true because people rarely know the exact risks that arise from their risky decisions. Nonetheless such ignorance does not always indicate the presence of a market failure that would necessitate a regulation or a tort of liability. The nature and extent of a problem and its effect on decision in comparison to people’s choice must be examined first to make an accurate information reference point (Arnould & Grabowski, 1981).

Occasionally risk perceptions do not matter if they are accurate or that sensible choices are arrived at as a result of the risk. An essential issue on how people show systematic biases on their perception of risks affects market systems as well as gives rise to compensating wage differentials. People will tend to overestimate events that have low probability of occurring and underestimate risks that have a high probability (Viscusi, 1993). For example in labor market the focus is based on how much wage the workers require so as to accept risks. This is based on the people’s willingness to pay for risk reduction (Viscusi, et al., 1987). According to Viscusi, et al.,(1987), when individuals are presented with a risk change they may require a large financial inducement so as to accept an increase in risk from what they are used to. This greatly exceeds their willingness to pay for higher reductions in risk even though these tradeoffs should be identical. This influence may have arisen from the perception bias from the people (Viscusi, et al., 1987). Risk perceptions reduce the rate at which individuals relate higher changes in the risk. In expressions of estimated compensating wage differentials, workers will always demand less amounts for compensation for every unit of actual risk faced since rise in risk is higher than it is believed (Viscusi, et al., 1987).

For example, take a market situation of a product where there is risk R* for injury from the product. From a previous risk model, R* matches to the equivalent of 1-π(s, h); therefore if a consumer displays an assessment of the risk that is subjective represented by p, and γ is the associated precision, where it represents number of draws that are equivalent to Bernoulli urn which is reflected in the subjective beliefs of an individual. Probabilistic beliefs that are more precise are represented by higher values of γ. The mere fact that people are not fully informed and have inherent subjective risk beliefs does not necessarily imply that individuals will underrate risk and engage in behaviors that are too risky (Viscusi & Gayer, 2002).

In most literature the roles played by regulation and tort liability on risk often hypothesize individuals underrating risks. However this is not the case as these patterns do not always hold on. Risk underrated by individuals is not always implied by the errors in risk beliefs of peoples. These risk beliefs biases are not always random but display variation in various systematic ways. Magnitude of risk is an important risk dimension. For example, the general pattern in the case of mortality risk is that people will overestimate minute risks along with underestimating huge risks. Market failure assessment arises from the notion of underrating risk and as a result depends on risk level. This is the risk levels that are associated perceptions of the risk that are associated by a particular market.

Zero reduction of risk has additional benefits to decision makers in risk regulation. When a risk is absolutely removed there would be no need of factoring risk presence when making a decision. Government regulators consider this phenomenon when making an important decision. Researchers have referred the phenomenon where people overreact as a result increased risk as reference risk bias as well as status quo bias. Product changes that will increase risk therefore tend to produce a response that is exaggerated (Samuelson & R, 1988). This therefore necessitates for a higher tradeoff rather than substantial risk reduction. People may therefore be willing to pay reduced values for substantial reductions in product risks. People will however refuse to purchase a product as a result of small increase in risk levels. They would demand substantial decrease in the price of the product for them to purchase the product. Publicity is another factor that leads to overestimation of risks as well. All risks are not always known in precision. Therefore the risk beliefs are not the only thing that is consequential but also the levels of their precision. However, the role of how tight these risks are is examined under risk ambiguity (Viscusi, 1998).

2.1.2 Risk Ambiguity

From the numerous sources of literature most biasness in the way people treat risk originate from how ambiguous the risk is. The Ellsberg paradox explains the situations that lead to display of biases by individuals (Khuon, 2012). In the Ellsberg paradox people are considered to be so risk averse such that they choose to stick with bad situations rather than face uncertain conditions.

The term ambiguity is a variable that is subjective. Nonetheless it should be possible to objectively recognize situations that are likely to present high ambiguity. This is through highlighting cases where there is scarce information, or unreliable and conflicting information, where different people expectations differ widely or confidence level estimates are very low (Ellsberg, 1961). Ellsberg focuses on the attitude of people in respect to risks that are ambiguous. These are risks where subjective judgment arises as a result of probability p representing information asymmetry. Situations where an opportunity to win a prize is presented to individuals, Ellsberg result is that people have a preference to accurate probabilities. If there is a chance of people incurring a loss, they will display ambiguity to probabilities of adverse effects. According to Ellsberg (1961), in cases where ambiguous risks exist, such as the case of mad cow disease , people would be expected to show ambiguity or be unwilling to acquire imprecise hazards as compared to those of the same magnitude that are precisely understood. The reluctance of people to incur risks that is ambiguous will accordingly prevent them from making market choices that are efficient. When risks are well identified along with not being understood, people will incur too small risks. Biasness in the formulation of policies by government is observed as a result of citizen preferences and therefore asserting pressure on the government. This results from the governments irrational responses to these ambiguous risks. Focusing on the particular character of risk instead of hazard magnitude reflects how ambiguity aversion of risk has moved from irrationality of an academic interest to government tool of policy making.

The character of risk in market context is dependent on the lack of full information. In most cases hazards are comprised of events that have low probability of occurrence and risk that are not understood. These attributes make people to be more unwilling to incur these risks (Viscusi, 1998).

Irrational Behavior and Addiction

Most analysis of market failure and conditions regarding to decisions of risk involve inadequate information about the risk. However there are other weaknesses of the choices. Addiction is one of the most prominent. This generally concerns market situations where consumption of a good leads to greater preferences in levels of the good and consumption of that good in the future. Changing the consumption pattern leads to substantial costs. This makes it difficult for consumption behavior of individuals to change. Some of the behaviors that have formed case studies for study of addiction are smoking, drug use and drinking. A market failure with reverence to addiction relies on the type of choices. People anticipate their own addiction in future and make rational choices to become addicted according to the rational addiction models (Gruber & koszegi, 2001). Market failure is not involved necessarily in fully anticipated addictions. This is so because people may rationally choose to get addicted to a product even though relinquishing addiction is expensive along with the product being harmful itself. Basic models of addiction recognize that consumption of commodities that are addictive ct in the current period is dependent on previous period’s consumption of the good ct-1 (Chaloupka, et al., n.d).

Irrational behavior models in a similar manner provide similar assumption on the intertemporal reliance of consumption. When people chose to become addicted there is a differentiating feature that is observed in rational models. This is the fact that these people will anticipate that their current consumption will ultimately increase their future consumption ct+1. In contrast to this there is an argument that addicted individuals are in continuous battle for self control. This argument observes that if people are myopic and place insignificant weight on themselves, then will behave in ways that will lead to addictive tendencies. This is the reason that leads to regulations or heavy taxations of products that are highly addictive (Schelling, 1993). Gruber & koszegi, 2001 hypothesizes market failure where individuals suffer from inconsistencies in their choices as a result of time. The main reason for regulating products that are addictive generally depends on the social implications of addiction to the society in general. Certainly potential harm is also an important consideration in this decision. Nonetheless addiction also leads to other costs. For example, drunk drivers may kill pedestrians and other pedestrians and drug addicts may lead to crimes so as to support their behaviors. Most regulatory activities of addictive habits are in most cases cojoined by externalities.

Externalities

The reason behind government regulations in these fields is because of the presence of externalities. Environment pollution is one of the most common source and example of externality. However externalities also exist in other areas as well. For instance in work environment the risky behavior of some of the workers may lead injuries of co-workers. This thus led to government issuing regulations on good work practices and conditions.

An organization that generates an externality on a third party have to chose its activity level so as to maximize profit as well as remodel the difference its exerting on its benefits and costs. When the third party that is receiving the externality is the public, and regulatory or liability sanctions are not exerted, this will lead to marginal costs exceeding social costs and thusthe company will be engaging in twin risky behaviors. Consequently a regulatory or liability sanction will give rise to a higher level of care through imposing a higher marginal cost to the organization (Cohen, 1986).

Externalities cannot always be observed in a negative aspect, there is externality consumption of a positive aspect. This observation is mainly in protcetive equipments such as helmets. Individuals are most likely to be reuctant to use them on their own because this will show weakness especially if it is a case of a contact sport. Despite this, if a high a number of players can be convinced to wear them, individual will thus voluntarily start using them. Individual choices in an observed market brings about a less preferred outcome consequently leading to a poor payoff to all individuals. This is opposite of a regulated outcome where peoples behavior is controlled so as to give rise to a positive externality (Viscusi & Gayer, 2002).

In other cases both positive and negative externality can be generated by products. A good example is the financial costs associated with cigarrettes. The morbidity effects as well as premature mortality effects of smokers is high in comparison to non smokers. Consequently externalities that increase social costs such as sick leaves and medical costs increases are incurred. In some situations there exists positive and negative externalities that exhibit diverse trajectories over time. This makes the intertemporal weights seems to have more impact with the exception of situations of simpler externality. A good example is air pollution which exerts a net external cost. In regard to the self financing characteristic of externalities of cigarette smoking, caution must be emphasized on the benefits and costs distribution. This is because these varies depending on the specific externality (Cohen, 1986). Therefore, while there may be no overall financial externality that is adverse, individuals responsible for all the components may not benefit. Despite all this, caution must be exercised while generalizing results attainned in the case of cigarette smoking to other products. However alcohol consumption may exhibit similar properties because its consumption in excess makes it a riskier product to consumers. A dominant concern to drunk drivers in this case is the substantial costs that are imposed on them. This makes the externalities- negative associated with alcohol be largely displayed (Manning, et al., 1989).

Modes of Intervention

All possible market interventions will not necessarily be deemed successful in improving market conditions just because there exists a market failure. This is because the present inefficiency may be too small or the intervention would not be benefitial. There are various forms of different interventions that can be applied in cases where there is need for intervention. These issues are concerned with the choice between litigation and regulation. There are various forms of regukation that a regulator may adopt depending on the institutional structure of the regulator (Shavell, 2004).

For example if a consumer decides to purchase a product which is dangerous and has an actual risk p* and p as the perceived risk, and p is less than p*. If the cost of the product is c and the income of the consumer is y. If the product does not cause injury, for consuming the product the consumer receives utility u ( y – c ). Utility v ( y – c ) if the product causes injury to the consumer. Likewise the consumer may decide not to consume the product and experience utility x (y). If the adverse effects associated with the consumption of the product generates a social cost which is denoted by g, then g will occur with a probability p*. The consumer purchases the risky product only if:

p) u (y – c) + pv (y – c) > x(y)

However this purchase will only be socially acceptable if;

(1 –p*) u(y-c) +p* v(y – c)-pg >x(y)

In such a choice problem to a consumer, there are two sources of market failure. This leads to a disproportion between private decision and valuations in the social decisions. Supply of information by the government could be used to remedy this disparity (Viscusi, 2006). The drive for this intervention is through supply of information could originate voluntarily from the market forces. However if this is not sufficient enough a government regulation can make it mandatory to disclose information. A good example is the mandatory disclosure of nutritional labeling in most food products.

Tax or penalty regimes are another form of market interventions that can be used in private and social incentives. In the consumer’s choice problem, in this case the regulation will be tailored in such a way that it will provide risk levels that individuals can only chose if they have full information on the risks associated with the product. They would also take into consideration external costs imposed due to their choices. The most prominent of these interventions are “sin” taxes that are imposed on alcohol and cigarettes (OECD, 2000).

Direct government intervention is another form of intervention in cases of market failure. These regulations take various forms and are enforced by different agencies. These regulations may involve the use financial incentives in monetary values or market oriented systems. Either tort liability also plays a role in many cases. The costs for liability will generate same motivation for safety adherence same to those arising from financial incentives from a regulation. Moreover, regulations with financial aspects have an effect on innovations because the firms level of research and development increases with liability costs as well as new products patents. However when these liability costs are too high they become counterproductive.

Decision Procedure for Regulatory Measures

Cost Benefit Analysis

For one to conduct a cost benefit analysis, a value has to be assigned to the benefit accrued by the regulation. In most health and safety regulations the most important concern is prevention of deaths (Viscusi & Gayer, 2002). A cost benefit analysis weighs the benefits accrued by a new regulation against the total costs arising from the implementation of the regulation. However many agencies are against the employment of a cost – benefit approach. For example the EPA asserts that this approach does not ultimately serve the society’s goal. This is as reflected by the congress’ Clean Air Act which aims to protect the air resources of the nation with the aim of promoting public health alongside social welfare. Nonetheless, such a goal is questioned as it is not in the nation’s interest when it is unaccompanied by contrasting benefits and costs that will be incurred as a result of the regulation (Calandrillo, 2001).

Every regulation gives rise to effects that can be categorized into two components. Foremost, regulations bring about costs to a firm. This has a ripple effect in that it will affect individual income. In a convectional cost benefit analysis of a regulation this cost effect forms one of its component. On the other hand individual risk taking decisions are affected by the costs. The second component of this cost benefit analysis is the benefit component. This is the effect that originates from the safety levels of a regulation. Safety levels that are higher are believed to decrease compensating differentials in wages as well as decreasing investment incentives on mortality enhancing infrastructures. For example higher safety levels can have a net effect on decreased health facilities investment. Government policies therefore will to balance these two effects so as to a desirable outcome (Viscusi, 1994). For a desirable benefit cost test of a policy the regulation must display a favorable effect on the expected utility of the individual. The representative individual, in practice represents a composite group of different individuals. From a regulation, parties benefiting from it may be different from those incurring the regulatory costs. A health care, for example, may display a greater marginal effect on mortality rates of individuals with low level of incomes (Viscusi, 1994).

For a regulation to pass the economic efficiency test, the minimum benefits must exceed the costs. In an ideal situation the allocation between benefits and costs must be maximized so that a regulation can pass this test (Hamilton & Viscusi, 1999). If the cost of a mortality reducing regulation is assumed to be c in the current period, and the average mortality risk reduction is s, affected people are represented by n and values of statistical life (VSL) is represented by v. In an ideal situation a policy or a regulation should be aimed at maximizing allocation between costs and benefits. This is represented by the maximum difference snv – c. Rarely do regulators hold on to this standard, rather they meet the requirement that benefits should always be more than the costs, that is;

snv > c. This test is justified, but it is not always convincing. In a lot of literature the concerns expressed about the benefit cost tests of public finance relates to Hicks – Kaldor criteria of compensation. This is the principle where gainers in a regulation are not always compensating the losers. In such a situation the intervention applied is not favorable to individuals having their welfare reduced.

Deviations from the approach of the benefit cost of a regulation are more diverse. One of the most notable is in the transportation safety regulation in that they must the cost- benefit test. That is;

S > c/nv

Alternatively the reduction of the risk must surpass the cost of the policy when divided by the affected population as well as being multiplied by VSL. Risk policies in contrast are governed by,

S >S*, where S* is the critical risk probability regulation.

In cost effectiveness terms, the benefit cost test can be written as c/sn ˂v, or life saved per cost is less than the critical value v. The relative performance of a regulation is characterized using this performance. This formulation can be used to assess the performance of a regulation in cases where individuals are reluctant to commit a specific VSL, v.

A person equates cost per unit risk in different areas of risk reduction actions in an efficient risk reduction regulation. For instance if a regulation imposes an unwarranted cost for every life saved it can only be justified if an individual is willing to spend more in order to acquire a facility that is marginally safer. Theoretical foundations of a market based methodology in estimation of v are articulated through this approach. Price risk as well as wage risk substitution values are mirrored based on market decisions. This thus makes it possible to estimate the value of v (Viscusi, 1994).

If in the benefit cost component an element of multiple time periods is introduced, then a time dimension t arises. Therefore if r is assumed to be the discount rate, then the cost benefit test on regulations imposing initial costs c at t is equal to zero will generate a stream benefit over time. In this case the VSL does not change over time, and could only change if there are effects on the income for example. Appropriate discount rates arouse controversies as well as what discount rate should be. This is so especially when it is concerned with environmental regulations and policies. The controversy on discounting rate is concerned on how future generations would be treated. Some literature puts arguments that future generations should not be discounted. The dilemma in this case is at what time does a generation end and another one start. For example if the current generation ends at T time and the future one starts at T+1, how will T value be determined? In addition, even if the value of T is determined how will discounted benefits to future generation imply about a policy criterion (Viscusi, 2006).

The benefit values of goods that are not traded in the market evokes controversy in that they will be undervalued and the costs associated with them may be overestimated. The concern on the undervaluing of benefits is largely predated by survey valuation methods of development that allow researchers to estimate benefits as too high rather than low. On the cost issue policymakers can learn from the past biases on their estimation.

Risk Analysis

Definition of the Concept

In regulatory situations there frequently exist different kinds of tradeoffs. A good example is prescription approvals of new drugs by FDA which focuses on the efficacy and safety of these drugs (Viscusi & Gayer, 2002). An efficient regulatory policy is highly unlikely to achieve. Therefore a less strict method of evaluating a risk would be risk- risk analysis. This is where the increase of the risk aspect of a regulation is compared against the reduction of risk by the regulation. Adoption of such an analysis promotes promulgation of regulations. This would result in the overall reduction of risk in the society. Various regulations are aimed at reducing risks to life; however there are some instances where new risks are created. An example is a case where a consumer may encounter a traffic accident and get injured while returning the car to the dealership as part of a recall (Graham, et al., 1992). Another example will be the introduction of new regulations in the construction and manufacturing activities which may lead to initial injuries as a result of these efforts. Therefore highly inefficient regulations have a highly probability of creating more risks than the way they reduce these risks. An intensive form of risk- risk analysis relates to how economic results exhibit a good relationship between individuals health and wealth. Costs are imposed on the society by regulations, thus leading to re-allocation of resources that would have been used on goods consumption. In case of health facilities it would have an impact of health enhancing. If a regulation diverts resources that are used to enhance health, then an impact that harms individual health is observed (Viscusi & Gayer, 2002).

In a case of UAW v OSHA in 1991, a D.C appellate judge Stephen Williams used risk – risk estimates to make a ruling on the OSHA’s safety standards on accidental startups of machines that were hazardous and perceived resulting to rise in deaths. He used explicitly the risk- risk regulatory criteria so as to suspend the reviewed OSHA proposed workplace regulations concerning air contaminants (Viscusi & Gayer, 2002). However in a later senate committee on Government Affairs and the General Accounting office (GAO) provided an advice deterring the use risk – risk analysis with a view that it constituted a benefit cost analysis. Cost per-life regulatory threshold adoption is roughly an order of size and larger than the value of life. This seems lenient as it permits issuance of regulations with safety- enhancing benefits that have minimum costs. On considering a large number of regulations enforced in the previous decade concerning health and safety does not meet the lenient tests of regulatory requirements.

Different methods used to estimate tradeoffs in the risk – risk approach can only be recognized through the theoretical linkages of statistical value of life from the side of saving a life alongside that of income loss level that would subsequently lead to a loss of statistical life. A regulation should thus enhance safety or lead to a probability of survival that is greater than zero at the very minimum if it does not pass the benefit cost test. The components of survival are the marginal effect of a safety level induced by regulation, the marginal effect of safety in decreasing investments in health as well as the financial cost effect of regulation on risk. This is due to positive income demand elasticity on health expenditures (Viscusi, 2006). If people reduce their precautionary