Supra-Regional vs. Regional Regulators in the Water Pollution Mitigation: Optimal Exemption Policies

Through the Water Framework Directive, the European Commission urges its Mem- ber states to reach a level of "good status" of water for 2015. This level can be different from the regional first-best. Neither the supra-regional regulator (European Commission) nor the regional regulator (Member State) knows perfectly this firstbest. Each region can estimate it thanks to a cost-benefit analysis (CBA). If the estimated first-best is lower than the "good status" level, the region can ask to be exempted from reaching the latter. In this paper, we show that regional regulators do not always invest largely in CBA in optimum, although under-investment increases the probability of being urged to reach the highest level of water quality. Besides, the optimal exemption policy announced by the supra-regional regulator, which depends on the CBA's investment, shall also depend on the local risk preferences and environmental vulnerability. If the exemption policy is uniform across the regions, we obtain that more risk averse and/or more environmentally vulnerable populations invest less in the CBA, contrary to the first intuition. Policy implications are discussed.