Using economic incentives to increase environmental performance standards

Command and control regulations, such as end-of-the-pipe effluent standards, end-of-the-smoke-stack emission standards and mandated pollution control technologies, have been the standard approach to environmental protection in developed and developing countries alike. Poor performance and high compliance and enforcement costs have encouraged many developed and some developing countries to explore the use of economic instruments either in support or replacement of command and control regulations. First, economic instruments such as environmental taxes, effluent charges and tradeable emission permits are known to be more cost-effective than effluent and emission standards or mandated technology in attaining a given level of environmental quality. Second, while regulations generate no revenues and require large budgets and bureaucracies to manage and enforce them, economic instruments, if properly designed, could both save in enforcement costs and generate substantial revenues for environmental investments. Third, economic instruments impose significantly lower compliance costs on industry because they allow polluters the freedom to choose their response as to minimize their cost of compliance: they can pay the charges, reduce or treat their waste, change their input combination, reduce their output, change their production technology or move to a different location. For example, while with regulations every firm must meet the same standard or reduce its emissions by the same amount as every other firm regardless of cost, with tradeable emission permits high cost pollution abaters are allowed to under-comply and in exchange pay low-cost pollution abaters to over-comply on their behalf as to achieve the same overall ambient quality level. The savings could be substantial for both the industry and the government. Examples of such measures include effluent charges on water pollution in the Netherlands and Germany; emissions charges on sulphur dioxide (SO₂) in Japan; charges on fuels, automobiles, pesticides and fertilizers, and deposit-refund systems for beverage containers and car batteries in Northern Europe; and emissions trading for air pollutants in the USA.

Policies that use economic incentives will be effective only to the extent that polluters and resource users respond to them. Responsiveness depends on three factors: ownership, competition, and differences among users. Often state-owned enterprises can be insensitive to policies that use economic incentives because they generally do not care much about costs. Lack of domestic and foreign competition dampens the pressures even on private businesses to minimize costs.

Another obstacle to the effective use of economic instruments in environmental policies is that businesses and individuals may be unable to invest in new technologies or pay for cleaner products. Examples include declining heavy industries in eastern Europe and poor people who use kerosene as their principal cooking fuel. Sometimes governments have subsidized the changes, by directly financing pollution control equipment or by using environmental protection funds to finance investments. Subsidizing environmental cleanup or resource use has an obvious problem: it sends the wrong signals to resource users and conflicts with the common interpretation of the polluter-pays principle. Subsidies may thus encourage a long-term increase in environmental damage, and their use should be well targeted, explicitly time-bound and carefully monitored – as, for instance, when they are provided only for the initial installation of pollution control equipment.

In general, regulatory policies, which are used extensively in both industrial and developing countries, are best suited to situations that involve a few public enterprises and non-competitive private firms. This is particularly true when the technologies for controlling pollution or resource use are relatively uniform and can easily be specified by regulators. Another area in which regulation may be appropriate is land use. Governments may use zoning regulations to attempt to create a land-use pattern that differs from the one that market allocations would produce. The aim of zoning laws in rural areas is typically to slow conversion of agricultural land or to preserve ecologically sensitive habitats. Urban zoning seeks to separate land uses so as to reduce adverse effects from, for example, industrial air pollution.

A move towards increased use of economic instruments for environmental management in either support or replacement of command and control regulations could be regarded as an indirect mechanism for financing Agenda 21 since environmental protection is advanced in a cost-effective manner, and budgetary resources are saved and new sources of revenues mobilized for investing in sustainable development. While immediate replacement of rigid regulations by economic instruments is unlikely, it would mark substantial progress towards the objectives of Agenda 21 if economic instruments were introduced as a source of financing. The experience of Malaysia with effluent charges, of Singapore with congestion fees, of Poland with a pilot tradeable permit scheme, and of Turkey with industrial relocation incentives offer grounds for optimism.