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BIJ 10,2

Using input-output analysis for corporate benchmarking

H. Scott Matthews and Lester B. Lave
Carnegie Mellon University, Pittsburgh, Pennsylvania, USA
Keywords Input/output analysis, Benchmarking, Life cycle costing, Social audit, Accounting, Pricing Abstract In recent years, cost-effective protection of the environment has become a more important goal for many businesses. Companies have been striving to reduce the environmental impacts of their products and packaging, while not incurring costs that put them at a competitive disadvantage. A key to accomplishing this goal is by benchmarking their performance against other companies. Benchmarking can be expensive, time consuming, or problematic because detailed benchmarking requires detailed, specic data that are generally condential. A screening level benchmark can accomplish much of the goal quickly and cheaply. Focuses on a tool to make quick, screening level benchmarks of US industrial environmental performance and discusses how it can be used to evaluate a plants environmental performance. Mentions other tools, notes its relationship to them, and discusses how it can be more broadly used. Finally, suggests ways that this type of benchmarking information can be used broadly within a rm for accounting and decision-making purposes.

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Benchmarking: An International Journal Vol. 10 No. 2, 2003 pp. 152-167 q MCB UP Limited 1463-5771 DOI 10.1108/14635770310469671

Introduction Companies in the USA and throughout the world face environmental activists and voters who demand improved environmental performance. Myriad legislation and regulations require companies to reduce their environmental discharges and clean up polluted sites. Faced with regulations, nes, consumer boycotts, bad publicity, and even shareholder and management pressure, companies have been trying to improve their environmental performance while not incurring costs that reduce their competitiveness. In the past, companies focused on product quality and cost, giving little attention to environmental discharges. Thus rms nd that, initially, they can actually lower costs and pollution discharges at the same time. However, as they push toward lower discharges costs increase. At some point, continuing to lower discharges could make the rm less competitive. What are reasonable goals for a rm that is attempting to be a good environmental citizen? One answer is that the rm should be performing better than its industry average and improving its performance over time. In the absence of benchmarking their environmental performance against competitors and comparable industries, rms have no idea how they compare to their competitors or to the industry best practice. In addition, without a management information system that enables them to trace the environmental expenditures and liability for current discharges back to individual products and their choices among processes and materials, managers cannot make informed decisions because they lack the necessary information.

In this paper we describe a tool that has been developed as a result of eldbased work with private organizations. The tool is designed to provide managers with the information required for making informed decisions. They are also designed to keep companies from incurring large future liabilities. We begin with some examples of environmental issues that companies have faced: . A plant making automobile supplies was hovering around zero protability and its disposal costs for scrap seemed high. Our investigation conrmed that they were producing a great deal of scrap in the plastic molding process. The result was high environmental disposal costs. More important was the excessive materials use and the fact that the plant generally had to work on weekends to fulll its quotas. Although the plant had gone to activity based costing (where the costs of production are explicitly connected with the activities that create them), the system was implemented so that it understated the effects of producing and managing scrap plastic by 60-80 percent. The high volume of scrap was an important indicator of fundamental problems in the plant that dwarfed the cost of scrap disposal. Thus, managers were looking elsewhere to nd a solution to the protability problem (Horney, 1998). . A few years ago, McDonalds was faced with environmental protests over its use of disposable foamed polystyrene clamshell containers for selling hamburgers. While the containers were ideal for insulating and protecting the food while providing portability, environmental groups protested that the containers were harmful to the environment. Unless McDonalds could nd a substitute package that was acceptable to the environmental groups and served customer needs, they faced a prolonged battle that would be costly to their public image. . Since 1968 American automakers have been required to control the tailpipe emissions of their vehicles. More recently, California, followed by states in the Northeast, went beyond this evolutionary approach to demand zero emissions vehicles (ZEV). This regulation ruled out internal combustion engines, requiring instead electric cars. Auto manufacturers found that producing these vehicles was much more expensive than conventional vehicles and customers found that the vehicles did not have acceptable range. Regulators insisted that the technology would improve with more R&D expenditures. These examples show companies and government agencies facing pressures from environmental groups, shareholders, and regulators who demand environmental quality and sustainability. In each case, the company wanted to be a good environmental citizen and was willing to make at least modest sacrices to do so (Lave and Matthews, 1996). In general, companies do not have the information to respond to these pressures in a timely way that deals with the issues cost-effectively.

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Setting realistic goals A major problem facing a company is what goal to set for current improvements. Although initially rms can both save money and lower environmental discharge, within a given technology, the costs start increasing as they attempt to ratchet down discharges. In many cases, the company can make a large reduction in discharges, but only at signicant cost. What goal should they set? Environmental demands seem to ask for zero discharges and even getting close is expensive. But this cannot be feasible while there is no assurance as to which level of performance is acceptable. Good companies also have to be able to sort through environmental demands to see which seem plausible but do not contribute to environmental quality, and which are most important. Simply doing what is demanded is likely to be expensive and never ending, and may in the end be entirely wasteful. We suggest that a reasonable goal is to exhibit better performance than the industry average and to improve continually over time. Benchmarking provides a good sanity check. This requires benchmarking against other companies in the same industry and comparable industries. Solving these problems is less obvious than it might appear. Unfortunately, setting goals that have the intention of beneting the environment have often turned out to be expensive, or even dysfunctional. For example, many US cities have had to discontinue all or part of their recycling programs because they were too expensive; some critics have charged that these programs harm, rather than help, environmental quality (Zandi, 1991). The 1996 German package recycling law (Eco-Cycle and Waste Law or Kreislaufwirstschafts und Abfallgesetz) cost more than twice what was originally expected; one result has been warehouses lled with material to be recycled because there are too few customers for the material. Currently, the recycling authority is willing to pay rms to recycle the material. We explore the reason why these are complicated issues and present some tools for answering them. In particular, we focus on three areas: rst, how to get a quick, rst order approximation of the environmental damage done by discharging pollutants within an industry; second, how to set reasonable goals for benchmarking across similar industrie; and third, how to provide this information to decision-makers to help them make informed decisions. Useful tools for environmental performance analysis To be useful for environmental analysis, tools must have four attributes: (1) They must address the whole problem and provide the desired information. The rst attribute requires knowing what information is required to make informed decisions about packaging fast foods, comparing an electric car to a gasoline powered car, or choosing which household waste to recycle. For a battery-powered car, one source of air emissions is the generation of the electricity used to charge the batteries.

If the electricity were generated by a dirty coal red power plant, air emissions are likely to be greater than powering the same eet of cars with low emissions gasoline engines. More important, current electric cars are powered by about 1,000 pounds of batteries. Mining, smelting and recycling the batterys metals will lead to large environmental discharges of highly toxic metals (Lave et al., 1995a,b; Steele and Allen, 1998). Another example is that making a car of aluminum rather than steel produces a lighter, inherently more fuel-efcient car. However, a great deal more energy is required to make aluminum than is required to make steel. How far would the steel and aluminum cars have to be driven before the total energy required for manufacturing and use is less for the aluminum car? To assess the implications for environmental quality and sustainability of a product or process, we must examine the full life-cycle of the alternatives, not just the energy and materials use or environmental discharges in one phase. Thus, to address the rst attribute, life-cycle information is required to make informed environmental decisions. (2) The tools must provide that information at the time when decisions are made (ideally in real time). (3) The tools must be inexpensive relative to the value of their information. The next two attributes, time and expense, do not have general answers, but rather depend on the particular decision. For microelectronics, delays in bringing a product to market are crucial, particularly because some products have lives as short as a few months in the market. The designer needs to make the decision quickly; information available next week is irrelevant. (4) They must be reliable in the sense that their information, while even if uncertain, is good enough to be helpful in making the decisions. Reliability is a complicated attribute. McDonalds probably did not desire to become an environmental exemplar; they simply wanted to sell hamburgers without bad publicity. To McDonalds, reliability meant getting all the relevant environmental groups to agree that a particular solution was environmentally benign. Conventional life-cycle analysis of paper versus polystyrene cups generated a great deal of controversy (Hocking, 1991; Wells, 1991; McCubbin, 1991; Caveney, 1991; Camo, 1991). The analysis indicated that making polystyrene cups resulted in more air pollution, while making paper cups resulted in more water pollution. Whether air pollution is better than water pollution is inherently controversial. The studies also found that the difference between materials was small relative to the difference among manufacturers and disposal practices. Materials selection decisions are inherently comprised of these types of tradeoffs.

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Developing tools requires difcult judgments. The toolmaker must decide which of the four criteria to emphasize. For environmental tools, researchers have tended to emphasize reliability. As a consequence, the tools are time consuming and expensive to apply and so are largely of academic interest. While tools must be reliable to be useful, they will not be used if they are not relatively inexpensive and produce answers in the relevant time period.

An environmental performance screening tool Now that the relevant screening tool attributes and the issues relevant to rms have been described, we discuss ways in which tools can be most helpful to companies. As noted above, rms need to be able to benchmark their performance against others within their industry. Looking at available industry-wide data can do this. If the condentiality of data is an issue, comparisons against industry averages can be done privately within the rm. A new tool has been created, building on Leontiefs input-output analysis (Leontief, 1936; Lave et al., 1995b; Hendrickson et al., 1998). Economic inputoutput life-cycle analysis (EIO-LCA, 2002) is based on a linearized model of production in the US economy supplemented with data on energy use, materials use, and environmental discharges. The basic assumption of inputoutput analysis is that inputs are proportional to outputs. For example, increasing automobile production by 1 percent is assumed to require 1 percent more of each of the current inputs. EIO-LCA uses EPA data on discharges of conventional air pollutants and toxic discharges and the census of manufactures and department of energy on use of fuels and other materials. The EIO-LCA tool calculates a wide range of factor inputs, such as bituminous coal and electricity, and a variety of environmental discharges, such as toxic air releases and greenhouse gases. It is available free on the Internet (available at: www.eiolca.net/). The data used are available to anyone who desires them; they are data collected by and reported to the federal government by companies and even individual plants. Thus the data may be over- or under-reporting actual releases. There are some limitations in terms of data availability, but the principal limitation concerns the level of aggregation. With only publicly available data, the tool can compare products by approximating them by the USA commodity sector in which they are manufactured. This approach is especially useful as a screening tool. With additional data on the composition of a product, the tool has been used to compare specic materials and products (Joshi, 1999). A downside of the wealth of data available is that the input-output tables are released only every ve years (e.g. 1992 and 1997), and with a signicant lag the 1997 benchmark input-output table will be released in late 2002. This limits comparisons to technology assumptions that are several years old. However, despite technological advances, purchases in the supply chains

of products are very inertial, with few signicant changes over short periods of time. The EIO-LCA model estimates both direct and indirect effects for the whole supply chain. By focusing on the direct effects (which come as a result of production by the manufacturer), a rm can gain insight into the industry average energy, environmental, or health and safety effects of production. In the previous example of an automobile plastic parts producer, they could compare their internally tracked data with industry benchmarks. As an example, Table I shows the direct aggregate sector effects of producing $1 million of automobile parts (from the motor vehicle parts and accessories sector) as estimated by EIO-LCA (the total column will be explained below). Of course, the estimates in Table I represent a fairly aggregate view of industry performance. In this case, factories in the motor vehicle parts and accessories sector which also produce brakes and oil lters would also be in this category. In some cases, rms in very aggregate sectors such as this one will have difculty using EIO-LCA for industry comparisons since some of the rms in a highly aggregate sector will have direct effects signicantly higher or lower than the average. Once rms have compared their performance against rms within their industry, they could also benchmark their performance against related industries. As mentioned, this might arise from the need to nd other, more appropriate, sectors to be used for comparison. In the case of the plastic auto parts plant mentioned previously, this could mean against other manufactured
Effect Electricity used (Mkw-hr) Energy used (TJ) Conventional pollutants released (metric tons) Sulfur dioxide (SO2) Carbon monoxide (CO) Nitrogen oxides (NOx) Volatile organic compounds (VOC) Lead Particulate matter less than ten microns in diameter (PM10) OSHA safety (fatalities) OSHA lost workday cases Greenhouse gases released (metric tons CO2 equivalents) Fuels used (metric tons) Ores used (metric tons) Hazardous waste generated (RCRA, metric tons) Toxic releases and transfers (metric tons) Weighted toxic releases and transfers (metric tons) Direct 0.18 0.93 0.1 0.07 0.12 0.2 0.0 0.0 0.00004 0.38 58 21 0 6.8 0.8 8.1 Total 0.96 16.8 4.3 5.8 2.9 0.92 0.01 0.45 0.0006 0.89 1,210 467 535 50 2.8 21.7

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Note: Assumes $1 million of production of SIC 3-714 motor vehicle parts and accessories Source: EIO-LCA (2002)

Table I. Direct and total coefcients of releases for automobile parts production

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plastic products industries. Table II shows a summary comparison of the direct effects across several similar plastic products manufacturing sectors. This comparison highlights the issues that arise when benchmarking rms even with similar materials and processes. While the direct energy use is similar across the four sectors, the environmental, health, and safety effects vary widely. This is a familiar result of benchmarking. As seen in Table II, these sectors vary widely in performance benchmarks. Conventional pollutant releases and fatalities are an order of magnitude difference. Energy use and greenhouse gas emissions are more similar. These differences can be explained by technology, regulation, or other effects. In addition, using a simple measure such as $1 million of product might not be a fair comparison. Product stewardship, supply chain and life-cycle analysis Product stewardship has motivated companies to consider the downstream implications of their products. For vertically integrated rms, that is the entire life-cycle. If the rms environmental management scope goes beyond the factory gate, then data across the production supply chain are needed for
Miscellaneous Hoses and products belts 0.35 1.04 0.06 0.01 0.03 0.92 0.02 0.00024 0.5 49 17 0.37 0.7 0.4 0.26 2.07 0.12 0.00 0.04 0.53 0.01 0 0.70 135 47 0.2 1.3 5.4

Effect Electricity used (Mkw-hr) Energy used (TJ) Conventional pollutants released (metric tons) Sulfur dioxide (SO2) Carbon monoxide (CO) Nitrogen oxides (NOx) Volatile organics (VOC) Particulate matter less than ten microns in diameter OSHA safety (fatalities) OSHA lost workday cases Greenhouse gases released (metric tons CO2 equivalents) Fuels used (metric tons) Hazardous waste generated (RCRA, metric tons) Toxic releases and transfers (metric tons) Weighted toxic releases and transfers (metric tons)

Auto-parts Footwear 0.18 0.93 0.1 0.07 0.12 0.2 0 0.00004 0.38 58 21 6.8 0.8 8.1 0.16 1.07 0.01 0.00 0.01 0.73 0.00 0 0.84 159 22 0.2 0.6 0.1

Table II. Comparison of performance benchmarks for four plastic product sectors

Note: Assumes $1 million of production of the following sectors: motor vehicle parts and accessories, rubber and plastic footwear, misc. plastic products, and rubber and plastic hoses and belts Source: EIO-LCA (2002)

comparison. Certainly, most rms are only concerned with the operation and management of their own facilities. Life-cycle analysis (LCA) is the key to making informed decisions about the implications for environmental quality and sustainability of choosing among materials, product congurations, and processes. EPA and the Society for Environmental Toxicology and Chemistry (SETAC) have developed the most widely used LCA method (Keoleian and Meneray, 1993; Vigon et al., 1993; Fava et al. (1991)). The rst step is to scope the problem, dening the boundaries of the analysis. The second step is a life-cycle inventory where the environmental discharges of all processes within the boundary are calculated. The third step is estimating the implications for the environment of these discharges. The nal step examines ways of reducing the environmental damage by reducing the discharges or changing the materials, product conguration, or processes. SETAC-EPA analysis has proven controversial (Portney, 1993). It is time consuming and expensive to determine the energy and resource inputs to a process and the resulting product output and environmental discharges. Hence, the boundaries are drawn tightly, including only the largest supplier or two at each stage. Since changing the boundaries changes the results of the analysis, often there is disagreement about where to draw the boundaries. The time and expense of getting data on each process also leads to using out of date data. Perhaps the most important problem is that few plant owners are willing to share proprietary data on their energy and material inputs, outputs, and environmental discharges. Thus, the individual plant data are rarely seen by anyone other than the LCA analyst. As a result, it is impossible for anyone other than the analyst to know the quality of the data. There are inherent difculties in relying on the person collecting the data for quality assurance of that collection process. Unless the data are open to scrutiny, there is little reason to have condence in the LCA results. As an example of LCA, Table III displays the results of a comparison of producing paper and polystyrene cups using EIO-LCA. In both cases, the manufacture of cups is approximated by the input-output sector in which the cups are manufactured. As seen below, there is no obvious winner in the comparison between plastic and paper cups. For example, while emissions of conventional pollutants are uniformly higher for paper cups, RCRA hazardous waste is more problematic across the board for plastic cups. It is not socially obvious which environmental effect is more problematic. However, one result of such an analysis is a better, more systematic understanding of the magnitude of impacts for the two types of cups. For product use, such as an automobile, the inputs could consist of fuel used over the vehicle lifetime, service estimates (parts and uids replaced and labor) and xed costs such as insurance, depreciation, etc. (Maclean and Lave, 1998). These inputs are approximated by their input-output sectors. As a result of its economy-wide boundary, EIO-LCA often leads to more complete results than

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Description Final demand Economywide output

Units $ million $ million

Polystyrene cup 0.300 0.745

Paper cup 0.600 1.463

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Table III. Selected summary environmental impacts from production of 10 million cups

Energy consumption Bituminous coal MT 100.04 232.6 Natural gas MT 79.72 63.6 Light fuel oil MT 9.18 25.1 Heavy fuel oil MT 4.67 24.8 Electricity Mk Wh 0.37 0.51 Total energy TJ 9.27 13.9 MT Non-renewable ore consumption Iron ores MT 8.84 13.94 Copper ores MT 85.64 33.79 Toxic releases Air MT 0.35 0.51 Water MT 0.04 0.05 Land MT 0.04 0.03 Total releases MT 0.6 0.62 Releases and transfers MT 1.7 0.92 Conventional pollutants Sulfur dioxide MT 1.7 4.2 Carbon monoxide MT 1.4 4.4 Nitrogen oxides MT . 1.5 3.5 Volatile organics MT 0.76 1.1 RCRA hazardous waste Generated MT 155 41 Managed onsite MT 151 40 Shipped out MT 4 2 Summary indices of emissions Global warming potential MT CO2 eq. 566 984 Notes: Polystyrene cups are approximated by the plastic materials and resins sector. Paper cups are approximated by the paperboard containers sector. The price of a polystyrene cup is 3 cents and a paper cup is 6 cents. MT = metric tons; MkWh = million of kilowatt-hours; TJ = terajoules; MT CO2 eq. = metric tons of equivalent CO2 emissions (using IPCC weights) Source: EIO-LCA (2002)

other LCA methods. EIO-LCA estimates some discharges or resource uses that are not typically associated with the product. For automobile parts manufacturing, suppliers use more energy than the assemblers. As an easy example of the difference between including just the direct effects of production, Table I shows the total (direct plus indirect) effects of producing $1 million of automobile parts. The total estimate further considers all purchases across the supply chain needed to produce the auto parts, as opposed to just those direct purchases made by the nal

manufacturer. With this expanded scope, it is possible to see several orders of magnitude more effects across the supply chain. This life-cycle perspective can also enhance benchmarking activities within a rm. Taking a life-cycle perspective of automobiles suggests that driving the automobile uses much more energy than producing the vehicle, servicing it, or disposing of it (MacLean and Lave, 1998). Incorporating the life-cycle perspective could facilitate a benchmark of competing vehicle designs (or materials choices, e.g. steel vs. aluminum). It could also show a specic vehicle design versus a generic (sector average) vehicle design over the life-cycle. Social cost accounting and pricing for environmental management A revolution has taken place in accounting in recent years to provide managers with better information. Unfortunately, the applications of activity-based accounting that we have seen neglect important aspects of a rms environmental costs and so lead to bad decisions. In our work with a number of Fortune 500 companies, we have not found a single company that has been able to compute the environmental costs and liabilities of individual materials, processes, products and designs. In addition, companies focus on their environmental expenditures, rarely attempting to quantify the extent of future liability from their disposal and other practices. Unfortunately, they have no direct information about how their costs and liabilities would change if they switched materials or processes, or changed their product congurations and disposal methods. A companys accounting system does not provide good information concerning these costs. Unfortunately, the accounting system is the management information system (MIS) for many companies. The accounting system is designed to satisfy the Internal Revenue Service (and state and local taxing authorities) and the Securities and Exchange Commission. Depreciation, the valuation of property and treatment of liabilities satisfy tax standards; only in the most remote sense can these accounting values be said to approximate current market values. Rather, accounting assumptions about depreciation, length of life of equipment and building, and values for capital goods are determined by tax authorities with little attempt to relate the assumptions to current market values. We stress that accounting systems are not designed to provide the sort of information that is needed to make informed decisions about products, production, and disposal. An MIS should provide executives with the information needed to make design, production, and disposal decisions. A reasonable MIS tabulates current environmental costs and likely future liabilities and traces them to the material, product, and process generating them, allowing decision-makers to assess their current status. A good MIS would give decision-makers information about how environmental costs and liabilities would change if there were a change in materials, design, or process. While enterprise resource planning (ERP)

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systems are becoming more pervasive within corporations, few are being used to fully support environmental, health and safety missions. We have been working with several companies on improving their MIS. A companion paper details some results and lessons learned from these investigations. In many cases, we nd that a company would increase its prot by changing design and practices to lower environmental costs and liabilities. For example, a plant doing injection molding for plastics seemed to have few environmental problems. It proudly displayed its equipment for recycling scrap polyethylene plastic. A closer examination revealed that the plant had a high scrap rate that increased its costs dramatically and increased its waste material, including the material that could not be recycled. The accounting system valued scrap parts at the cost of materials, understating the costs by the amount of labor and machine time going into each part, as well as disposal costs. Furthermore, the system credited them with the value of the recycled plastic without charging them for the labor and machines required for the recycling. Thus, it saw scrap as almost costless. In fact, scrap parts were three to ten times more expensive than the accounting system estimated. Faced with the real costs of this scrap, it saw that decreasing scrap rates was the most important short-term priority of the plant. We nd that few rms attempt a quantitative assessment of their possible liabilities from environmental discharges. They assume that satisfying current environmental laws and regulations will protect them from future liability. Our history indicates this assumption is not prudent. Many Superfund sites resulted from companies that satised all applicable environmental laws and regulations or even went far beyond these regulations. A more prudent assumption is that any discharges of toxic materials into the environment could result in future liability. The MIS described so far attempts to help rms increase their prots by generating better information about their costs and liabilities. However, a rm can be fully in compliance with all environmental regulations and still impose large costs on society. For example, a paint company in Los Angeles that was in compliance with its permits might have emissions of volatile organic compounds that were a major contributor to ozone levels. The next step in constructing a better MIS would be to use the social, rather than private, costs of discharges. If a company calculated its costs on the basis of social costs, it would see where it was imposing large costs on society and perhaps where it is likely to be regulated in the future. Using social costs would show the rm where corporate citizenship could contribute the most to environmental quality. Having social costs substantially greater than private costs indicates a possible problem. In our judgment, a rm should have this information to make informed decisions about its design, processes, and materials.

By applying known estimates of the damage associated with air pollution, rms could account for the social costs of air pollution associated with a product or process. Tables IV and V show the comparative external air pollution costs of producing paper and plastic cups (using the same assumptions as in Table III). The values in Tables IV and V display a range of social cost valuations resulting from air pollution emissions, and are found by multiplying these valuations by the tons of conventional pollutants and greenhouse gases emitted for the 485 sectors in the US economy. They are given in percentage terms and represent a valuation of how much society might be willing to pay to avoid these air emissions. See Matthews and Lave (2000) for details on the valuation method. The values suggest that the social air pollution costs of manufacturing paper cups are roughly twice the social cost of an equivalent number of plastic cups. If only the social costs of air pollution are important, then plastic cups should be chosen. The values estimated only consider social costs of air pollution, and none related to water or release of toxins. Including these would further increase estimates of social costs.
Low Total Paper and paperboard mills Electric services (utilities) Pulp mills Crude petroleum and natural gas Paperboard containers and boxes Trucking and courier services, except air Railroads and related services Industrial inorganic and organic chemicals Natural gas distribution Coal 0.6463 0.2181 0.1867 0.0534 0.0259 0.0223 0.0186 0.0154 0.0145 0.0122 0.0115 Median 2.9785 0.9188 0.7151 0.2035 0.1677 0.1571 0.1519 0.0743 0.0682 0.0764 0.0789 High 9.0536 2.9466 2.0225 0.751 0.3396 0.3165 0.5585 0.4139 0.2164 0.1407 0.1348

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Table IV. External air pollution costs for paper cups (percent)

Low Total Electric services (utilities) Industrial inorganic and organic chemicals Plastics materials and resins Crude petroleum and natural gas Natural gas distribution Railroads and related services Trucking and courier services, except air Coal Other repair and maintenance construction Nitrogenous and phosphatic fertilizers 0.3076 0.1128 0.0557 0.0346 0.0337 0.0091 0.0064 0.0061 0.005 0.0045 0.0042

Median 1.4912 0.4319 0.2618 0.1865 0.2184 0.057 0.0309 0.05 . 0.0345 0.0145 0.02

High 4.3139 1.2216 0.8311 0.5264 0.4423 0.1049 0.1721 0.1837 0.0589 0.0839 0.052

Table V. External air pollution costs for plastic cups (percent)

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Finally, we offer a more radical suggestion. To an economist, environmental pollution arises because companies do not face the social costs of environmental discharges. Environmental discharges are an externality and so lead to market failure. As Pigou suggested in 1918, the most straightforward way to deal with an externality is to impose a tax equal to the external cost to society (Pigou, 1918). If rms face the correct prices for their discharges, they will have incentives to make the right decisions regarding these environmental discharges. In this case, there would be no need for regulatory agencies to compel rms to modify their behavior the combination of the market system and social cost pricing would lead to the right behavior. The notion of social cost accounting and pricing is both attractive and frightening to executives. It is attractive to think about getting away from EPA control. However, the pollution charges could be large, adding to costs and reducing sales. We think social cost pricing is worth serious attention even though rm costs would be increased in the short term. Social cost pricing would force society to clarify its environmental goals and set priorities. Is the social cost of emitting a pound of sulfur dioxide one cent, one dollar, or $100? How important is abatement of sulfur dioxide compared to abating emissions of nitrogen oxides (NOx) or emissions of a carcinogen such as benzene? Setting these values would unleash market incentives. Firms would nd ways to abate environmental discharges in order to lower their production costs. Entrepreneurs would search for new technologies to abate discharges or technologies that are naturally low polluting. These incentives lowered the cost of abating sulfur dioxide under the 1990 Clean Air Act by more than two-thirds (Burtraw, 1995). Social cost pricing would give better information to consumers about the environmental costs of their purchases. The market price would reect the full social costs. Customers would not need recommendations from consumer groups about which products to buy, since the product price would embody its environmental costs. Finally, social cost pricing would give greater stability to rm decisions. Currently environmental legislation and regulation are subject to chaotic, often punitive behavior. For example, automobile companies have a difcult time predicting new emissions regulations. They also point out that they are subject to much more stringent NOx emissions controls than are stationary sources. Under social cost pricing, cars and electricity generation plants would face the same marginal costs for NOx emissions control, leading to lower total costs of NOx abatement. Social cost pricing would not replace regulation. For discharges that lead to global or regional rather than local problems, social cost pricing would be sufcient. For greenhouse gases, CFCs, and, to a lesser extent, the precursors of acid rain and ozone, social cost pricing would be expected to lead to the desired

level of abatement, the only issue. For suspended particulate matter and toxic emissions, emissions can cause local hot spots that could result in unacceptably high local risks, even though the overall level of abatement is achieved. Regulations would still be needed to deal with these hotspot problems. In the paper versus plastic cup example, given public outcry about air pollution, consumers would face a fully costed price of paper cups that was between 0.6 and 0.9 percent higher, and 0.3 to 0.4 percent higher for plastic cups. A social cost analysis can aid benchmarking activities within the rm by showing dollar-valued social cost comparisons of environmental discharges against production cost. If air pollution damages are the primary concern, then the method used would give social cost benchmarks of the two alternatives. The rm could use the benchmarking data to minimize the total cost of production with air pollution damages included. Conclusion The rst step in improving environmental quality and sustainability is to clarify social goals. The environmental legislation of the 1970s set out environmental goals, although Congress was far from clear as to the precise goals. The next step is to fashion tools that allow rms to calculate the implications for their protability and social goals of their decisions regarding product design (choice of materials and product conguration), processes, materials, and disposal practices. To be useful, these tools must address the rms problems, must be quick, inexpensive, and sufciently reliable to be worth using. We have described a tool that can help to improve this decision making, both for the private sector and for government. EIO-LCA can provide good estimates of impacts for industries, especially if the time and resources are not available for a detailed analysis. It can be used to help rms benchmark their progress broadly within an industry or across common industries. Finally, social cost accounting and pricing provide information so that executives can make informed decisions. These tools enable environmentally-conscious companies to examine the implications of their decisions and track future performance or efciency gains. They also create a demand for better data on composition of a product or component and of the materials use and environmental discharges associated with a particular manufacturer. Many of the companies purchasing components of consumer products are now demanding this information from their suppliers. Environmental management tools, such as ISO 14000, require this information. Although they have complained about providing these data, much of the condential information (e.g. TRI and RCRA) has already been disclosed. The required reporting has led to large reductions in environmental discharges to the benet of the environment and society more generally.

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Local, state, federal, and international law is requiring rms to evaluate and improve their environmental performance and look forward to sustainable operations. Companies that fail to comply with the letter and spirit of these laws will be censured by stockholders, employees, and the community, and ned by regulatory agencies. Until now, companies thought of compliance as a painful, costly process. The tools we describe can help rms to lower their costs, better understand the implications of their products, and predict future social and regulatory concerns.
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