2.7 Conclusions
Economics provides a conceptual and analytical framework for developing and applying market-based instruments to environmental externalities. The efficient price of pollution exactly balances marginal damage with marginal benefit. Looked at another way, the marginal cost of abatement equals the marginal benefit associated with pollution reduction. In order to achieve the efficient outcome, we need information on both costs and benefits – both sides of the “market” must somehow reveal these data.
Turning to the practical aspects of policy, the cost of abatement should in principle be known to industry and it is plausible to assume cost-minimising behaviour. When faced with a price for pollution individual polluters will seek less polluting technology, including adjusting management. Obtaining information on the damages avoided is not as straightforward. Damages are measured in terms of their impact on the welfare of consumers and producers. Furthermore, the damage estimate is assumed to include different spatial and temporal impacts. Obviously, the benefit side of the equation is absent in real world settings. Unlike costs, there is no market mechanism in operation that we can rely on to signal the value of damages avoided.
We cannot assume that the environmental regulator is omniscient. Although practical policy might – and indeed should be – guided by estimates of value we are left with a “second-best” approach where a standard is set. This issue is how best to achieve the desired standard. Historically, central and local governments have relied primarily on regulations to meet their environmental goals. From the outset we must note that both CAC and polluter pays require a standard. Governments usually set standards after considering scientific evidence and stakeholder preferences. Thus the issue for sustainable development is whether or not a policy instrument achieves the standard at least-cost. To do otherwise unnecessarily increases expenditures in the present. Regulations that impose a technology on industry will not adequately account for the heterogeneity of firms nor will the imposed technology minimise cost. Regulation will not produce the desired outcome at least-cost. Empirical evidence supports this conclusion.
If we step away from the Pigouvian ideal and admit the practical (costly) difficulty of measuring damages then the damage function can be thought of as a target (ie, a vertical line in terms of Figure 1). Policy makers have a choice of using a pricing instrument or quota. Polluter pays provides an opportunity cost to the polluter that acts as an on-going incentive to implement less costly abatement technology.
Defining tradable rights to the standard provides similar incentives. Tradable permits provide a degree of certainty over achieving environmental outcomes, provided of course, enforcement is effective. Defining the permits as shares – as opposed to a quantity – provides flexibility for temporal adjustments to the target. Factors limiting the use of tradable permits include complexity of establishing a functioning market; agreement on how to initially allocate rights; and, concerns about market concentration. In contrast, although polluter pays may prove easier to set the initial “price” this price may not result in the environmental outcome desired. Getting price adjustments through the political process might prove difficult.
Economic instruments produce a richer response on both sides of the market. For example, a tax on the sulphur content of fuel would work on both sides of the market, consumers would be encouraged to save on fuel and producers encouraged to supply lower sulphur fuels. Tradable rights also create incentives. For example, the cost of TDPs would become an integral part of the cost of production – firms will face an incentive to develop and use less-polluting technologies and consumers of the product will have to at least meet the additional cost of production.
There is no blueprint or algorithm to follow when considering whether to regulate or turn to market-based instruments. Good economic reasons might exist for adopting regulations. For example, diffuse non-point sources of pollution are difficult to tackle using market based instruments. Technology will continue to offer scope for switching from regulation to market based instruments. For example, road access is electronically priced in Melbourne, some cities overseas are seriously considering pricing access to storm water, the technology exists to price vehicle emissions, and so on. Analysts and policy advisors must first be able to characterise the problem and carefully weigh-up the relative merits of each approach. Furthermore, choice between taxes and quotas as instruments of pollution control should be sensitive to the nature of the uncertainties involved.
This section has shown how better defined property rights can make a significant contribution to sustainable development. Devolving rights to communities, empowering them to “manage” the local resource, providing technical (and possibly financial) assistance, is a powerful instrument. There are good working examples of how devolution to non-government organisations has produced significant environmental gains.
In conclusion, market based instruments score relatively highly in terms of sustainable development. Concepts such as total economic value and concern for future generations can be directly addressed and incorporated. Within the generic set of options laid out above, there exists a huge range of potential applications. Discovering the most appropriate instrument can only come about from careful analysis. Ill-conceived proposals for the use of MBIs will not gain the acceptance needed for implementation.
