Using economic instruments for sustainable development

Utilizing the potential of economic and financial instruments to make capital work for the environment and sustainability rather than against it.

Economic instruments (usually taxes and charges) are used to achieve specific and sustainable local, national and international development goals. There is scope for appropriate economic instruments, including market mechanisms, to be used to meet the objectives of sustainable development and fulfilment of basic needs. Their effective use can be explored by governments, in cooperation with business and industry, as appropriate.

Integrating environmental considerations into sectoral policies requires proper pricing of environmental resources and internalization of environmental costs. Market-based instruments cannot, however, entirely replace direct regulations and administrative interventions in environmental policy. They have to be linked to and supplement clearly defined standards on emissions and environmental quality insofar as the existing legal framework is not sufficient.

The overriding benefit of economic instruments is their promise of a more flexible, cost-effective and efficient approach to environmental management. They can help reduce the financial burden inherent in achieving sustainability whilst enhancing the opportunity to mobilize new financial resources. However, economic instruments should be part of an integrated package of measures that seek to address, within the context of sustainable development, not only merely the symptoms of environmental degradation but also their underlying causes. The goals they are designed to meet should be accurately defined and based upon environmental science, economics and social considerations. Clear definitions should clarify the distinction, in practical terms, between taxes and charges.

All concerned (including intergovernmental organizations, industry, NGOs, consumer groups and economic and environmental policy makers) should participate in the debate on choice, design and implementation of such instruments. The distributive effects upon different social and economic groups may require compensation mechanisms to be put in place. These should not, however, compromise the original environmental and economic goals.

This strategy features in the framework of Agenda 21 as formulated at UNCED (Rio de Janeiro, 1992), now coordinated by the United Nations Commission on Sustainable Development and implemented through national and local authorities. Agenda 21 recommends reforming or recasting existing structures of economic and fiscal incentives to meet environment and development objectives. It recommends providing scope for appropriate economic instruments, including market mechanisms, in harmony with the objectives of sustainable development and fulfilment of basic needs.

Guidelines for the use of market-based instruments for environmental policies have been developed since 1991 by OECD, subsequently recommended by ECE for use in countries in transition, and reviewed by OECD and ECE and at a workshop under the auspices of the United Nations Commission on Sustainable Development.

[Transitional economies] The transition to a market economy provides an opportunity for these countries to increase the scope and use of economic instruments for environmental management. Progress in implementing economic reforms should facilitate the introduction of rational allocations of resources and reduce environmental pollution by clarifying property rights, removing subsidies and addressing environmental liabilities, provided that environmental concerns are properly integrated. The following factors favour the introduction of economic instruments in countries with economies in transition: (a) privatization and restructuring of enterprises; (b) removal of state subsidies and soft budget constraints; and (c) price liberalization and increased market competition.

The following factors constrain the introduction of economic instruments in transitional economies: (a) low political support and limited public interest; (b) little willingness to pay for environmental services; (c) insufficient institutional development; (d) high rates of inflation, making indexation necessary; (e) limited capacity to design and implement economic instruments; and (f) limited enforcement capacity. Speeding up economic integration will reduce the influence of these constraints.

A number of developing countries are experimenting with innovative approaches involving emissions and effluent charges, market-based extraction charges, and tradable permits. For example, Chile and Peru have recently introduced new fishing laws involving tradable harvesting permits; China is enforcing new charges on sulfur dioxide emissions; Thailand is experimenting with performance bonds for hazardous waste; and Malaysia has recently strengthened its system of effluent charges.

Although economic instruments are primarily applied at national and local levels, they can be adopted equally effectively at international and regional levels. The major constraint to wide-scale use is the concern of enterprises and policy makers for international competitiveness. However, an expert workshop (Prague, 1995) considered that existing trading experience could be applied to a non-binding pilot programme in international carbon dioxide (CO₂4) emission trading within the context of relevant international conventions; also that opportunities exist to implement some form of charge on air transport which is consistent with the "polluter pays" principle. It is almost always necessary, however, to adopt a case by case approach in order to select and design the most appropriate economic instruments for specific environmental problems in the context of specific groups of countries ( e.g. developing, developed and transitional). Off-the-shelf approaches are unlikely to work.

Economic instruments can provide incentive for private firms to develop new methods of controlling pollution, so utilizing information about pollution control methods that is not usually available to regulators.