Market-based instruments

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A. Role of various environment-related measures

Market-based instruments (MBIs)

Unlike the Command and Control (CAC) approach, MBIs use price or other economic variables to provide incentives for polluters to reduce harmful emissions. MBIs include charges, subsidies, marketable (or tradable) permits and other MBIs including deposit/refund systems, eco-labelling, licenses, and property rights. In general, MBIs may have the following advantages and disadvantages;

Advantages of MBIs

Cost effective as it offers a possible lowest cost to society to control pollution
Provides incentives for technology innovation and diffusion
Decrease externality or make the one that makes the decision bear the cost of that decision
Generate revenues for the government

Disadvantages of Standards

Institutional constraints - such as underfunding, inexperience unclear jurisdiction and lack of political will - limit the effective implementation of MBIs.
Administrative intensity (i.e., monitoring requirements, legal design requirements, public consultation needs and enforcement of collection needs) remains high and thus MBIs cannot substitute for weak institutions or command and control policies.
Have the potential to be regressive, as they make cost of goods and services higher.
If not designed properly, have the potential to have perverse effects (e.g., water pollution charge may cause more pollution if based on effluent concentrations and not on total pollution load)

a. Charges

A charge or a tax is a fee that is imposed on a pollutant in proportion to the amount of the pollutant released into the environment. Charges are based on the 'Polluter Pays Principle (PPP)', which requires that a polluter must bear the cost of any pollution abatement necessary to maintain environmental quality.

Charges may be classified into the following categories :

Emission (or effluent) charges is based on the actual amount of the pollutant discharged.
Product charges or levies is a mark-up on the price of a pollution-generating product that is based on the amount responsible for pollution. An example of a product charge is a carbon (fuel) tax.
User charges is a fee levied on the user of an environmental resource based on the costs of treating emissions (or effluents) that affect the resource.
Administrative charge is a service fee for implementing or monitoring regulation.
Betterment charge is a fee levied for private properties benefiting from public projects.

Advantages of charges

Disadvantages of charges

Charges give consumers and firms an economic incentive to reduce pollution.
Unlike standards, which are applied uniformly to all polluters, charges enable firms to adopt a cost-effective solution to pollution abatement.
Compared to standards, there is a stronger incentive for firms to adopt new technology in order to lower the charges they have to pay.

An 'optimum' standard is often difficult to set for certain non-market environmental commodities.
Firms could pass on a portion of the tax or charge to consumers in the form of higher product prices.
Imposing a tax could also lead to job losses as firms minimise their costs in order to increase pollution abatement.
Costs of monitoring the compliance may be high if charges are based on the emission.

See also

Figure 1: Government policies for integrating environmental considerations into economic decisions

Example

Korea: The Republic of Korea's Effluent Charge System

The effluent charge system was introduced in 1983 in the Republic of Korea as a penalty for violations of the regulatory standard. However, the charge rate was too low and the penalty was not a threat enough to comply. (More...)

Malaysia: The Malaysian Effluent Standard-Charge System

The Malaysian Effluent Charge System, instituted with the passage of the Environmental Quality Act of 1974. The Act requires that all dischargers pay a fee to obtain a license to discharge waste into public water bodies. (More...)

Pacific island countries: The Energy Conservation Fund

Key sectors in environmental management and relevant economic tools.

Thailand: The Energy Conservation Fund

In March 1992, the Government of Thailand passed the Energy Conservation Promotion Act. With regard to the Act, taxes were imposed on almost all types of fuel to finance for energy conservation measures. (More...)

b. Subsidies

A subsidy is a payment or tax concession that assists firms to reduce pollution. In that sense a subsidy is the opposite of taxes. The subsidy could be offered in proportion to the per unit reduction in pollution, or it could be offered for the purchase of pollution abatement equipment or technology.

Comparison of charges and subsidies

In theory, both taxes and subsidies should result in the same optimum level of environmental quality. However, there could be the following differences:

where there is unrestricted entry into the industry, subsidies could attract more firms and therefore aggregate pollution could increase in the long-run
subsidising polluters may be seen as socially unjust because some may see this as taking income away from the society

c. Marketable (or tradeable) permits

A relatively new addition to MBIs is the marketable (or tradeable) permit system which originated from the U.S. Under this system, the government issues a fixed number of permits or "rights to pollute" equal to the permissible total emissions and distributes them among polluting firms in a given area. A market for permits is established and permits are traded among firms. Firms that maintain their emission levels below their allotted level can sell or lease their surplus allotments to other firms or use them to offset emissions in other parts of their own facilities.

The concept of marketable permits may also be used to manage natural resources such as fisheries. This system is referred to as Individual Transferable Quotas (ITQs). Under this system, property rights to a specified quantity of fish harvest are distributed among firms or auctioned off to the highest bidders. The holders of ITQs may use, sell or lease them to other firms. Over time, the ITQ systems leads to an efficient use of effort and harvest. An example of an ITQ is given below.

Advantages of permits	Disadvantages of permits
Allocation of permits is determined by market forces The ability to sell permits is an incentive for firms The system makes allowance for industrial development. The system can generate income for the government.	The market for permits may not be perfectly competitive. Well-develped markets may constraint the permits' system. Administrative, monitoring and enforcement costs may be high.

Example

Australia: Individual transferable quotas (ITQs) for the fishery industry

The Australian government introduced an ITQ for the Australian fishery in 1984. By making the quotas transferable, rational behavior is facilitated amongst fishers. The quotas can be transferred which creates efficiencies by using the resources in their highest valued use. (More...)

Poland: The Polish Pilot Project in Tradeable Emissions Permits

The project aims to show that the economic instruments that have been successful in the U.S. also offer a significant potential for pollution abatement in the transition economies. (More...)

d. Other MBIs

Other MBIs include

Deposit-refund systems

A deposit-refund system consists of a 'deposit', which a front-end payment for potential pollution, and a 'refund' which is a guarantee of a return of the deposit upon proving that the pollution did not take place. Deposit-refund schemes have built-in economic incentives similar to charges. For example, the 'deposit' is an attempt to force the consumer to account for the cost of improper waste disposal by making an upfront payment. On the other hand, the 'refund ' serves as a reward for proper waste disposal.

Advantages of deposit-refund systems:

Disadvantages of deposit-refund systems:

It is a voluntary scheme that attempts to change environmental behaviour at least cost to the government.
Monitoring and enforcement costs are minimal because it requires limited supervision.
The system can be used to encourage recycling and more efficient use of raw materials. For example, the 'deposit' can be considered as a tax to encourage firms to use raw materials more efficiently, while the 'refund' encourages them to properly dispose of their waste products.

If refunds are too low, the public may not have an incentive to participate in the scheme.

Example

PNG: Bottle reuse and drink can recycling in Port Moresby

The use of returnable bottles is cheaper in economic and energy terms than non-returnable bottles or cans. Therefore PNG Bottle Industry Pty Ltd has an incentive to offer refunds. (More...)

Korea: The waste disposal deposit-refund system in the Republic of Korea

The waste disposal deposit-refund system was implemented to motivate manufacturers to comply with the proper waste collection and treatment methods. (More...)

Ecolabelling and ISO standards

In the ecolabelling or performance rating approach, firms are required to provide information on the final end-use product. Firms are performance rated based on ISO 14000 voluntary guidelines that include the following: zero discharge of pollutants, adoption of pollution abatement technology, submission of mitigation plans. The 'ecolabels' are attached to products that are determined to be 'environmentally friendly'.

Example

Republic of Korea: Promotion of eco-labeling and ISO14000

To meet the international norms and standards emerging rapidly, Korea is promoting better management of the environmental labeling system and the adoption of ISO 14000 standards. (More...)

Licenses, concessions and quotas

Licenses, concessions and quotas have traditionally been used for the management of environmental resources such as forests and fisheries. For example, many Pacific island countries (PICs) use licenses and access fees to manage their exclusive economic zones (EEZ). However, due to lack of knowledge about the financial performance of foreign fishing fleets, and inadequate monitoring and enforcement capacity, most PICs are unable to capture a fair proportion of the rents from fishing.

Example

PNG: Foreign fisheries vessels in PNG

The PNG Government receives about K15 million per annum in license fees from foreign fishing vessels. Due to PNG's limitation to monitor fishing activities, many of the vessels avoid paying resource rent to the State. (More...)

Traditional property rights

In recent years, there has been a realization that traditional or customary communal rights systems can provide insights into the design of modern systems of natural resource management. In most developing, as well as developed countries, resource managers have concentrated their management efforts on licenses and quotas in order to prevent overexploitation of natural resources such as fisheries and forests. In many cases, these efforts have been unsuccessful. Customary communal rights systems, whereby local people manage their own resources through the establishment of private or communal ownership over common property resources, have better chances of success. This is because the "owners" of the resource have an interest in its current and future productivity and would be inclined to control exploitation so as to maximise the net benefits.

Example

Sri lanka: Sri Lankan Coastal Fisheries System

Sri Lankan coastal fisheries have a history of traditional property rights. Outsiders are not allowed access to the fishing grounds. This restriction on access may be instrumental in the observation that Sri Lankan coastal fishermen earn higher incomes, compared to local fishermen in other Asian countries. (More...)

Performance bond/environmental guarantee fund

These are bonds/funds put up by proponent of projects to ensure that funds are available for environmental clean up/rehabilitation/compensation to adversely affected stakeholders in the event of environmental accidents and/or abandonment by the project proponents.

Example

Philippines: Environmental Guarantee Fund