Using economic instruments to mitigate climate change

Economic instruments, such as environmental taxes or tradable permits, are promising ways of advancing the internalization of environment costs, as is the removal of subsidies that support practices harmful to the environment and health.

New approaches must be adopted to environment and health regulations. The role of some economic instruments, such as environmental taxes, is likely to grow in most countries. Such instruments meet the need to raise revenue for the state budget and provide signals that direct economic choices towards sustainable paths.

Analysis of environmental problems reveals the fact that economic activities are overwhelming contributors to them. This is particularly true when producers and consumers do not compensate for the economic losses which result from the impact of their activities on the environment. In fact, they have no incentive to reduce this impact, or to take it into account in their investment decisions and lifestyle choices. Yet the decisions taken today set patterns of production and consumption that will be irreversible for several years.

Perverse incentives in the transport, agriculture and energy sectors are also economic instruments, but ones which directly favour activities that have an excessive impact on the environment.

One way of addressing environment problems is to ensure that economic actors compensate more fully for all the costs resulting from their activities, including otherwise hidden environmental costs. Such an approach can be summarized in the two principles of "the polluter pays" and "the user pays". In the case of environment costs, the phrase "internalization of external effects" is often used, since it is a question of making economic actors take account of costs that were "external" to their decision-making.

The world economy is experiencing a continuing trend towards liberalization and deregulation. Privatization of state-controlled activity is part of this trend. This raises concern that control over polluting activities is also looser, as private investors may pay even less attention to environment and health considerations than the state did in the past. However, liberalization also increases the role of prices and, in turn, this magnifies the effectiveness of incentive policies that have an effect on prices (such as environmental taxes). Liberalization can therefore be used both as an opportunity and a rationale for using economic instruments on a larger scale to integrate environmental concerns into the economic choices of investors and consumers.

This can be done by means of such economic instruments as environmental charges and taxes. When these costs are high, it may be unreasonable to charge the full amount immediately. Nevertheless, adopting plans to do so progressively sends a clear signal to the various economic actors. This will modify their anticipation of future prices, as they know they will have to pay, in the future, for the real environmental costs that they will engender. As a result, this will drive them to design their long-term choices and strategies in an environmentally friendly way.

In the case of transport, economic instruments such as fuel taxes, urban tolls and parking fees can be used to modify the price of road transport, so that it reflects more accurately the full social costs of the impact on the environment. The United Kingdom introduced a fuel tax "escalator" that has increased the tax on road fuels by 5% every year since 1993. In the Netherlands, constitutional barriers have been lifted to allow for a national road toll system, which could be operating in a few years. These initiatives could help the economic actors adapt their behaviour and make structural changes that would support a sustainable transport system.

Negotiations (in Kyoto in 1997 and in Buenos Aires in 1998) have increased the focus on economic instruments, and especially on flexibility mechanisms such as tradable permits and on fiscal policy (through a carbon tax), as a means of coping with the issue of climate change. This should benefit the search for similar solutions to other environment and health problems.

In the choice of instruments, preferences, lifestyles and cultural references should receive greater attention. In rapidly evolving situations, solutions are often short-lived and need to be flexible. Economic instruments can be integrated into broader policy packages that include regulations and voluntary schemes to reduce environmental impacts.

The United Nations agencies and financial and other international or nongovernmental organizations have converging objectives: to improve health, alleviate poverty and advance economic efficiency. Their approaches to the environment and health issues faced by countries are also converging: to promote the use of economic instruments in increasingly market-driven economies and to correct distorted economic mechanisms. They believe that the use of economic analysis and an understanding of the interactions between economic policy and the environment can make a valuable contribution to environmental improvements. The Environment Action Plan Task Force for the countries of central and eastern Europe and the transboundary programmes of the United Nations Economic Commission for Europe (ECE), place emphasis on economic analysis and instruments.

Even if many countries do make some use of economic instruments in their environmental policy, their implementation is rarely aimed at (or sufficient for) making the economic actors take account of environment and health costs. In many countries of WHO's European Region (members of the European Union, countries of central and eastern Europe, newly independent states and others), the incentive function of economic instruments often attracts only limited interest or understanding from the authorities, including ministries of the environment and of health. On the whole, little progress has been made on implementing policies to internalize environment and health costs. Environment-related health problems can thus be expected to increase.