Polluters and collective action: theory and evidence.

• Author: Damania, Richard

1. Introduction

   The seminal theory by Olson (1965) predicts that industries with fewer firms have a greater ability to undertake collective action. They organize cooperative political action more easily because greater concentration lowers the cost of political action. (1) The empirical evidence is inconclusive, however. Andres (1985), Masters and Keim (1985), Heywood (1988), and Humphries (1991) find positive effects of industry concentration on the probability of making political action committee (PAC) contributions (see also McKeown 1994). Pittman (1976) finds that concentrated industries generate greater contribution levels. Grier, Munger, and Roberts (1991) find an inverted U-shaped relationship between the level of PAC formation and industry concentration, with a maximum political participation rate occurring at a four-firm concentration ratio around 0.45. Esty and Caves (1983) and Zardkoohi (1985) report ambiguous effects of concentration on PAC contributions. (2)

   In this paper we suggest an alternative perspective on firms' ability to organize collective action which, to our knowledge, has been ignored so far. The novel argument is that industries that face multiple regulations (a greater number of policy issues) find it easier to overcome collective action problems and sustain lobbying. In particular, we focus on the difference between firms in polluting and clean industry sectors. Using a simple repeated game framework similar to Spagnolo (2000), we argue that firms in industries that are naturally polluting (because of their input requirements), and therefore incur pollution abatement costs, will face an additional policy battle compared with other industries, everything else equal. (3) This enables such industries to sustain greater cooperation and lobbying. This is because firms seeking to form a lobby group face a free-riding problem due to a limited amount of "enforcement power" available to punish deviation and ensure cooperation. Firms that face multiple areas of regulation have an advantage in the formation of lobby groups because they have a greater amount of enforcement power available to reallocate between policy issues. When joint lobbying gives large gains in environmental policy, this surplus can be reallocated to trade policy, for example. Free-riding behavior on trade policy lobbying may more easily be disciplined. The prediction that emerges from our theoretical model is that polluting industries are relatively less affected by the free-riding problems involved in organizing political action, and we thus expect the level of political contributions to be higher in these sectors. (4)

   We evaluate this prediction using a cross-section data set of U.S. manufacturing industries. Our empirical model builds on a multiple-equation model by Gawande and Bandyopadhyay (2000), who test the well-established theory of Grossman and Helpman (1994) on the pattern of protection (their theory takes lobby group formation as given). We augment Gawande and Bandyopadhyay's model with an additional equation for environmental policy stringency. (5) The empirical results lend support to our theory. Industry PAC contributions, and thus the level of lobby group cooperation, are greater in industries with larger pollution abatement costs. This result is robust to several measures of lobby group formation and environmental policy.

   The present paper contributes to the recent literature on the formation of lobby groups. In the area of pollution taxation, Damania and Fredriksson (2000) argue that collusive industries may more easily form lobby groups that oppose such taxes. Using a related setup, Damania and Fredriksson (2003) discuss the effect of (exogenous) trade liberalization on environmental policy formation when lobby group formation is endogenous. Pecorino (1998) and Mitra (1999) discuss the formation of trade lobby groups. (6) Neither of these papers explore the relationship between collective action and the number of policy instruments, however. (7)

   Empirical work is severely lacking in this area, although some related work does exists. Our paper complements Grier, Munger, and Roberts (1994), who argue that industries that potentially may benefit from government assistance contribute more in corporate PAC contributions but are hindered by collective action problems. Pittman (1988) shows that the level of federal regulations (primarily measured as the level of capital expenditures on pollution abatement induced by Environmental Protection Agency regulations) significantly determines campaign contributions. To our knowledge, no study addresses the influence of the number of regulations on the degree of political action, however.

   The paper is organized as follows. Section 2 sets up a stylized model of the lobbying game. Section 3 describes the econometric model, and section 4 discusses the data. Sections 5 and 6 report the empirical results and the sensitivity analysis, respectively, while section 7 concludes.

2. A Theoretical Example

   In order to illustrate our argument, we outline a stylized infinite horizon model with complete information, which makes use of the framework developed by Spagnolo (2000) in his study of linkages of environmental and trade policies in international agreements. The model will underline the reasons why we may expect pollution intensive sectors to have an easier time to sustain lobbying.

   We have two industry sectors, k = A, B, which are identical except that sector A's production is polluting whereas sector B's production is nonpolluting. Each industry sector has two identical firms, h = a, b. Thus in total we have four firms, [k.sup.h]. All firms face at a minimum n government policies each denoted by i, that is, trade policy, corporate and wage taxes, etc. Because sector A firms are polluting, they in addition encounter an environmental policy, and these firms face n + 1 government policies. For simplicity we set n = 1, where the common government policy is a trade policy. Thus, policy issue i = 1 is trade policy, and policy issue i = 2 is environmental policy. (8) Both sectors thus produce tradable goods.

   The two firms in each industry sector wish to organize joint trade policy lobbying. However, they face a prisoner's dilemma since when one firm contributes to the lobbying effort its rival has an incentive to deviate. The one-period strategic interaction on policy issue i is represented as a prisoner's dilemma in which each firm may choose to either contribute ([C.sub.i]), or free ride (defect) ([D.sub.i]). In industry k, the one-shot policy prisoner's dilemma game is characterized by firm h's action space [[THETA}.sup.k,h.sub.i] = {[C.sub.i], [D.sub.i]},

   k[member of]{A, B}, h[member of]{a, b}, and policy payoff functions [[pi].sup.kh].sub.i]:[[THETA].sup.k.sub.i] [right arrow] [R.sup.2], where [[THETA].sup.k.sub.i] = [[THETA].sup.ka.sub.i] x [[THETA].sup.kb.sub.i]. This generates the following policy payoff matrix for policy i = 1 (trade policy) for the sector k firms, where [Y.sub.i] > [X.sub.i] > [N.sub.i] > [Z.sub.i], and [Y.sub.i] + [Z.sub.i] 0, I = 1,2. In sector B, the payoff from the policy outcome on trade policy alone enters each firm's aggregate static profit functions [[PI].sup.h.sub.B] = [PI]([[pi].sub.i]), h = a,b, with [differential][[PI].sup.h.sub.B]/[differential][[pi].sub.i] > 0. In each period t firm h in sector k maximizes the net present value of profits from policy outcomes NP[V.sup.k,h] = [[summation].sup.[infinity].sub.[tau]=t] [[delta].sup.[tau]-t][[PI].sup.[tau]], where [delta]

   The problem is analyzed in a supergame, that is, the firms are assumed to interact over an indefinite period of time. We let firms use trigger strategies as discussed by Friedman (1971), and we focus on symmetric stationary lobbying sustained by stationary punishment strategies. First, assume that the trigger strategies apply only to one separate policy issue at a time. Thus, defection on trade policy is punished by abandoning all cooperation on trade policy by reverting to the one-shot Nash equilibrium. In sector A, taking environmental policy (policy 2) as given, the one-period gain from unilateral defection on trade policy lobbying only is given by

   [G.sup.A.sub.1] = [[PI].sup.A]([Y.sub.1], [[pi].sub.2]) - [[PI].sup.A]([X.sub.1], [[pi].sub.2]) (l)

   and the cost of defection is given by

   [C.sup.A.sub.1] = [delta]/1 - [delta] [[[PI].sup.A][X.sub.1], [[pi].sub.2]) - [[PI].sup.A] [N.sub.1], [[pi].sub.2]). (2)

   In the polluting sector A, joint lobbying on policy issue 1 is sustainable if [G.sup.A.sub.1] [less than or equal to] [C.sup.A.sub.1]. Suppose instead that the firms in sector A punish a deviator in both policy dimensions. Thus, if a firm deviates, the rival firm's retribution strategy is punishment in both trade and environmental policies. In this case the deviating firm would chose to deviate on both policies (see Bernheim and Whinston 1990). Then, the gain from deviation is given by

   [G.sup.A.sub.1,2] = [PI]([Y.sub.1], [Y.sub.2]) - [PI]([X.sub.1], [X.sub.2]), (3)

   and the cost of deviation is given by

   [C.sup.A.sub.1,2] = [delta]/1 - [delta][PI]([X.sub.1], [X.sub.2]) - [PI]([N.sub.1], [N.sub.2])]. (4)

   In this case, joint lobbying on both policy issues is sustainable if [G.sup.A.sub.1,2] [less than or equal to] [C.sup.A.sub.1,2] In sector B the optimal punishment strategy involves deviation on policy 1 (trade policy), and thus joint lobbying requires [G.sup.B.sub.1] [less than or equal to] [C.sup.B.sub.1].

   The focus of our discussion is the fact that firms seeking to form a lobby group may face a problem of limited enforcement power. The expected short-term gains from deviation from lobbying may be greater than the long-term gains from cooperation. In this case, lobbying is not sustainable. However, firms that interact in multiple areas of regulation (policy issues) have an advantage in the formation of lobby groups due to the greater amount of available...