Market-based environmental policy instruments

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In environmental law and policy, market-based instruments (MBIs) are policy instruments that use markets, price, and other economic variables to provide incentives for polluters to reduce or eliminate negative environmental externalities. MBIs seek to address the market failure of externalities (such as pollution) by incorporating the external cost of production or consumption activities through taxes or charges on processes or products, or by creating property rights and facilitating the establishment of a proxy market for the use of environmental services. Market-based instruments are also referred to as economic instruments, price-based instruments, new environmental policy instruments (NEPIs) or new instruments of environmental policy.

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Examples include environmentally related taxes, charges and subsidies, emissions trading and other tradeable permit systems, deposit-refund systems, environmental labeling laws, licenses, and economic property rights. For instance, the European Union Emission Trading Scheme is an example of a market-based instrument to reduce greenhouse gas emissions.

Market-based instruments differ from other policy instruments such as voluntary agreements (actors voluntarily agree to take action) and regulatory instruments (sometimes called "command-and-control"; public authorities mandate the performance to be achieved or the technologies to be used). However, implementing an MBI also commonly requires some form of regulation. Market-based instruments can be implemented systematically, across an economy or region, across economic sectors, or by environmental medium (e.g. water). Individual MBIs are instances of environmental pricing reform.

According to Kete (2002), "policymaking appears to be in a transition towards more market-oriented instruments, but it remains an open-ended experiment whether we shall successfully execute a long-term social transition that involves the private sector and the state in new relationships implied by the pollution prevention and economic instruments rhetoric." [1]

History

For example, although the use of new environmental policy instruments only grew significantly in Britain in the 1990s, David Lloyd George may have introduced the first market-based instrument of environmental policy in the UK when a Fuel tax was levied in 1909-1910 during his ministry. [2]

Transferable permits

A market-based transferable permit sets a maximum level of pollution (a 'cap'), but is likely to achieve that level at a lower cost than other means, and, importantly, may reduce below that level due to technological innovation.

When using a transferable-permit system, it is very important to accurately measure the initial problem and also how it changes over time. This is because it can be expensive to make adjustments (either in terms of compensation or through undermining the property rights of the permits). Permits' effectiveness can also be affected by things like market liquidity, the quality of the property right, and existing market power. [3] Another important aspect of transferable permits is whether they are auctioned or allocated via grandfathering.

An argument against permits is that formalising emission rights is effectively giving people a license to pollute, which is believed to be socially unacceptable. However, although valuing adverse environmental impacts may be controversial, the acceptable cost of preventing these impacts is implicit in all regulatory decisions. [3]

Taxes

A market-based tax approach determines a maximum cost for control measures. This gives polluters an incentive to reduce pollution at a lower cost than the tax rate. There is no cap; the quantity of pollution reduced depends on the chosen tax rate.

A tax approach is more flexible than permits, as the tax rate can be adjusted until it creates the most effective incentive. Taxes also have lower compliance costs than permits. However, taxes are less effective at achieving reductions in target quantities than permits. Using a tax potentially enables a double dividend, by using the revenue generated by the tax to reduce other distortionary taxes through revenue recycling. [3] There can also be a conflict between objectives with a tax: less pollution means less revenue.

Market-based vs command and control

An alternate approach to environmental regulation is a command and control approach. This is much more prescriptive than market-based instruments. Command and control regulatory instruments include emissions standards, process/equipment specifications, limits on input/output/discharges, requirements to disclose information, and audits. Command and control approaches have been criticised for restricting technology, as there would be no incentive for firms to innovate. [3] Empirical studies have shown the opposite; external price changes can induce innovation as companies are forced to address the market failure of under-investment. [4]

Market-based instruments do not prescribe that firms use specific technologies, or that all firms reduce their emissions by the same amount, which allows firms greater flexibility in their approaches to pollution management. However, command and control approaches may be beneficial as a starting point, when regulators are faced with a significant problem yet have too little information to support a market-based instrument. Command and control approaches can also be preferred when regulators are faced with a thin market, where the limited potential trading pools mean the gains of a market-based instrument would not exceed the costs (a key requirement for a successful market-based approach). [3]

Market-based instruments may also be inappropriate in dealing with emissions with local impacts, as trading would be restricted to within that region. They may also be inappropriate for emissions with global impacts, as international cooperation may be difficult to attain.

For a variety of reasons, environmental advocates initially opposed the use of market-based instruments except under very constrained conditions. However, after the successful use of freely traded credits in the lead phasedown in the U.S. environmental advocates recognized that trading markets have benefits for the environment as well. [5] Thereafter, beginning with the proposal of the acid rain allowance market, environmental advocates have supported the use of trading in a variety of contexts.

See also

Related Research Articles

Emissions trading is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants. The concept is also known as cap and trade (CAT) or emissions trading scheme (ETS). Carbon emission trading for CO2 and other greenhouse gases has been introduced in China, the European Union and other countries as a key tool for climate change mitigation. Other schemes include sulfur dioxide and other pollutants.

Environmental economics is a sub-field of economics concerned with environmental issues. It has become a widely studied subject due to growing environmental concerns in the twenty-first century. Environmental economics "undertakes theoretical or empirical studies of the economic effects of national or local environmental policies around the world. ... Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming."

<span class="mw-page-title-main">Externality</span> In economics, an imposed cost or benefit

In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's activity. Externalities can be considered as unpriced goods involved in either consumer or producer market transactions. Air pollution from motor vehicles is one example. The cost of air pollution to society is not paid by either the producers or users of motorized transport to the rest of society. Water pollution from mills and factories is another example. All consumers are all made worse off by pollution but are not compensated by the market for this damage. A positive externality is when an individual's consumption in a market increases the well-being of others, but the individual does not charge the third party for the benefit. The third party is essentially getting a free product. An example of this might be the apartment above a bakery receiving the benefit of enjoyment from smelling fresh pastries every morning. The people who live in the apartment do not compensate the bakery for this benefit.

Participatory economics, often abbreviated Parecon, is an economic system based on participatory decision making as the primary economic mechanism for allocation in society. In the system, the say in decision-making is proportional to the impact on a person or group of people. Participatory economics is a form of socialist decentralized planned economy involving the common ownership of the means of production. It is a proposed alternative to contemporary capitalism and centralized planning. This economic model is primarily associated with political theorist Michael Albert and economist Robin Hahnel, who describes participatory economics as an anarchist economic vision.

<span class="mw-page-title-main">Carbon tax</span> Tax on carbon emissions

A carbon tax is a tax levied on the carbon emissions required to produce goods and services. Carbon taxes are intended to make visible the "hidden" social costs of carbon emissions, which are otherwise felt only in indirect ways like more severe weather events. In this way, they are designed to reduce carbon dioxide (CO
2) emissions by increasing prices of the fossil fuels that emit them when burned. This both decreases demand for goods and services that produce high emissions and incentivizes making them less carbon-intensive. In its simplest form, a carbon tax covers only CO2 emissions; however, it could also cover other greenhouse gases, such as methane or nitrous oxide, by taxing such emissions based on their CO2-equivalent global warming potential. When a hydrocarbon fuel such as coal, petroleum, or natural gas is burned, most or all of its carbon is converted to CO
2. Greenhouse gas emissions cause climate change, which damages the environment and human health. This negative externality can be reduced by taxing carbon content at any point in the product cycle. Carbon taxes are thus a type of Pigovian tax.

An environmental tax, ecotax, or green tax is a tax levied on activities which are considered to be harmful to the environment and is intended to promote environmentally friendly activities via economic incentives. A notable example is carbon tax. Such a policy can complement or avert the need for regulatory approaches. Often, an ecotax policy proposal may attempt to maintain overall tax revenue by proportionately reducing other taxes ; such proposals are known as a green tax shift towards ecological taxation. Ecotaxes address the failure of free markets to consider environmental impacts.

A Pigouvian tax is a tax on any market activity that generates negative externalities. The tax is normally set by the government to correct an undesirable or inefficient market outcome and does so by being set equal to the external marginal cost of the negative externalities. In the presence of negative externalities, social cost includes private cost and external cost caused by negative externalities. This means the social cost of a market activity is not covered by the private cost of the activity. In such a case, the market outcome is not efficient and may lead to over-consumption of the product. Often-cited examples of negative externalities are environmental pollution and increased public healthcare costs associated with tobacco and sugary drink consumption.

Free-market environmentalism argues that the free market, property rights, and tort law provide the best means of preserving the environment, internalizing pollution costs, and conserving resources.

Eco-capitalism, also known as environmental capitalism or (sometimes) green capitalism, is the view that capital exists in nature as "natural capital" on which all wealth depends. Therefore, governments should use market-based policy-instruments to resolve environmental problems.

<span class="mw-page-title-main">Environmental policy</span> Government efforts protecting the natural environment

Environmental policy is the commitment of an organization or government to the laws, regulations, and other policy mechanisms concerning environmental issues. These issues generally include air and water pollution, waste management, ecosystem management, maintenance of biodiversity, the management of natural resources, wildlife and endangered species. For example, concerning environmental policy, the implementation of an eco-energy-oriented policy at a global level to address the issues of global warming and climate changes could be addressed. Policies concerning energy or regulation of toxic substances including pesticides and many types of industrial waste are part of the topic of environmental policy. This policy can be deliberately taken to influence human activities and thereby prevent undesirable effects on the biophysical environment and natural resources, as well as to make sure that changes in the environment do not have unacceptable effects on humans.

<span class="mw-page-title-main">Carbon price</span> CO2 Emission Market

Carbon pricing, also known as cap and trade (CAT) or emissions trading scheme (ETS), is a method for nations to reduce global warming. The cost is applied to greenhouse gas emissions in order to encourage polluters to reduce the combustion of coal, oil and gas – the main driver of climate change. The method is widely agreed and considered to be efficient. Carbon pricing seeks to address the economic problem that emissions of CO2 and other greenhouse gases (GHG) are a negative externality – a detrimental product that is not charged for by any market.

<span class="mw-page-title-main">Carbon Pollution Reduction Scheme</span>

The Carbon Pollution Reduction Scheme was a cap-and-trade emissions trading scheme for anthropogenic greenhouse gases proposed by the Rudd government, as part of its climate change policy, which had been due to commence in Australia in 2010. It marked a major change in the energy policy of Australia. The policy began to be formulated in April 2007, when the federal Labor Party was in Opposition and the six Labor-controlled states commissioned an independent review on energy policy, the Garnaut Climate Change Review, which published a number of reports. After Labor won the 2007 federal election and formed government, it published a Green Paper on climate change for discussion and comment. The Federal Treasury then modelled some of the financial and economic impacts of the proposed CPRS scheme.

Environmental pricing reform (EPR) or Ecological fiscal reform (EFR) is a fiscal policy of adjusting market prices to account for environmental costs and benefits; this is accomplished by the utilization of any forms of taxation or subsidy to incentivize or disincentivize practices with environmental impacts.

<span class="mw-page-title-main">Carbon emission trading</span> An approach to limit climate change by creating a market with limited allowances for CO2 emissions

Emission trading (ETS) for carbon dioxide (CO2) and other greenhouse gases (GHG) is a form of carbon pricing; also known as cap and trade (CAT) or carbon pricing. It is an approach to limit climate change by creating a market with limited allowances for emissions. This can lower competitiveness of fossil fuels and accelerate investments into low carbon sources of energy such as wind power and photovoltaics. Fossil fuels are the main driver for climate change. They account for 89% of all CO2 emissions and 68% of all GHG emissions.

<span class="mw-page-title-main">Economics of climate change mitigation</span> Part of the economics of climate change related to climate change mitigation

The economics of climate change mitigation is the part of the economics of climate change related to climate change mitigation, that is actions that are designed to limit the amount of long-term climate change. Mitigation may be achieved through the reduction of greenhouse gas (GHG) emissions and the enhancement of sinks that absorb GHGs, for example forests.

Cap and dividend is a market-based trading system which retains the original capping method of cap and trade, but also includes compensation for energy consumers. This compensation is to offset the cost of products produced by companies that raise prices to consumers as a result of this policy.

In economics, an environmentally honest market system refers to a market which reflects ecological and environmental health costs such as resource depletion and pollution.

<span class="mw-page-title-main">Nonpoint source water pollution regulations in the United States</span>

Nonpoint source (NPS) water pollution regulations are environmental regulations that restrict or limit water pollution from diffuse or nonpoint effluent sources such as polluted runoff from agricultural areas in a river catchments or wind-borne debris blowing out to sea. In the United States, governments have taken a number of legal and regulatory approaches to controlling NPS effluent. Nonpoint water pollution sources include, for example, leakage from underground storage tanks, storm water runoff, atmospheric deposition of contaminants, and golf course, agricultural, and forestry runoff.

Economic Instruments for water policies are tools based on incentives ad disincentives; they change conditions to enable economic transactions or reduce risk, aiming at increasing environmental quality.

Command and Control (CAC) regulation finds common usage in academic literature and beyond. The relationship between CAC and environmental policy is considered in this article, an area that demonstrates the application of this type of regulation. However, CAC is not limited to the environmental sector and encompasses a variety of different fields.

References

  1. ↑ Nancy Kete, "Environmental policy instruments for market and mixed-market economies" (January 1994). Utilities Policy, Vol. 4, 1: pp. 5-18.
  2. ↑ Jordan, A., Wurzel, R., Zito, R., and Bruckner, L. (2003). Policy innovation or 'muddling through'? 'New' environmental policy instruments in the United Kingdom. Environmental Politics, 12 (1). pp. 179-200.
  3. 1 2 3 4 5 Guerin, K. (2003). Property Rights and Environmental Policy: A New Zealand Perspective.Wellington, New Zealand: NZ Treasury
  4. ↑ R D Van Buskirk; C L S Kantner; B F Gerke; S Chu (2014-11-14). "A retrospective investigation of energy efficiency standards: policies may have accelerated long term declines in appliance costs". Environmental Research Letters. 9 (11): 114010. Bibcode:2014ERL.....9k4010V. doi: 10.1088/1748-9326/9/11/114010 . ISSN   1748-9326.
  5. ↑ •Alan P. Loeb, "Addressing the Public's Goals for Environmental Regulation When Communicating Acid Rain Allowance Trades," The Electricity Journal, May 1995.
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