Modeling the Choice Between Regulation and Liability in Terms of Social Welfare

Using a formal political economy model with asymmetric information, we illustrate the conditions under which an environmental protection system based on extending liability to private financiers is welfare superior, inferior or equivalent to a system based on an incentive regulatory scheme subject to capture by the regulatees. We explicitly consider the following factors: the cost of care and its efficiency in reducing the probability of an environmental accident, the social cost of public funds, the net profitability of the risky activities, the level of damages, and the regulatory capture bias. We characterize in such a parameter space the regions where one system dominates the other.

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