Accounting for defensive investments in demand for air quality

About

Willingness to pay (WTP) for well-being frequently depends on factors that directly influence said well-being, such as the probability of mortality in a given area, school quality, local crime rates, etc., but it also depends on compensatory investments that help to determine these factors. Empirical literature on this subject has almost exclusively focused on the direct effects (e.g., health outcomes) of these factors and left the defensive investments largely unmeasured. As examples, there has been little effort to measure: the use of medications or air filters to protect against poor air quality, parental expenditures on supplemental tutoring to improve educational outcomes for their children, or the costs of alarm systems and additional security to protect against crime. All of these defensive investments are costly, and it seems reasonable to presume that the available estimates of WTP for a wide variety of factors have been substantially understated.

To address this gap in the literature, we developed a measure of WTP for air quality improvements that accounts for both the direct health impacts and defensive investments leveraging the NOx Budget Trading Program (NBP) that operated in the midwestern US from 2003-2008 as a natural experiment. As a measure of defensive behavior, we investigated whether medication usage responds to changes in air quality. We also provide new evidence on how air pollution affects more commonly studied outcomes like mortality and hospitalizations.

Approach

The empirical application is based on a quasi-experiment that exploits three sources of variation in the introduction of an emissions market for nitrogen oxides (NOx). The NOx Budget Trading Program (NBP) operated a cap-and-trade system for over 2,500 electricity generating units and industrial boilers in the eastern and midwestern United States between 2003 and 2008. Because this market had the goal of decreasing ozone pollution, which reaches high levels in summer, the market operated only between May 1 and September 30. Specifically, we used a triple-difference estimator that compares pollution, defensive expenditures, and health outcomes in the NBP participating and nonparticipating states, before versus after 2003, and summer versus winter.

Key findings

The empirical analysis produces several key results. First, there was a substantial decline in air pollution emissions and ambient concentrations as a result of the NBP. In 2005–2007, NOx emissions were nearly 40 percent lower, but almost entirely during the summer months when the NBP was in place. Second, these improvements in air quality produced substantial benefits.

Medication expenditures decreased by about 1.6 percent or roughly $800 million annually in the 19 eastern and midwestern United States where the NBP was in force. This is an important measure of defensive expenditures, because, for example, the annual cost of prescription medications for asthma is reported to exceed the monetized value of any other component of asthma’s social cost, including mortality, emergency department admissions, or lost productivity. Third, our estimates of the effect of NOx emissions on health and defensive investments suggest a significant causal link between NOx emissions, medication purchases, and mortality. Overall, it is striking that defensive investments account for more than one-third of our estimate of total WTP for reductions in NOx emissions.

Partners

This study was completed in collaboration with Dr. Michael Greenstone at the University of Chicago and Dr. Joseph S. Shapiro at Yale University.