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Economic Incentive Systems And Regulatory Approach Towards Pollution Economics Essay

Environmental economics study the impact of our economic activity on the resources that we extract from the environment and the way we use it which ends very often in the form of pollution. Pollution is characterized as waste rejected into the air, soil or water that can reduce the value of those resources we use. Such a phenomenon has impacts on our society and goes against the idea of sustainable development which states: “sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs” (Bruntland Commission, 1987). The costs of pollution can be very high and are not directly faced by the polluters themselves. As an example, if a firm rejects toxic waste into a river, they won’t suffer directly the consequences but the inhabitants of the city just next to the river will. Pollution will infect the water they drink and the fish they eat, so they will have to pay to find solutions to this issue. Environmental economics is trying to limit this kind of issues: how to regulate pollution emission and how to make the polluter pay? Governments use many economic instruments to achieve this goal. We can classify all these strategies into two groups. One is a traditional regulatory approach where governments impose a large panel of pollution limits through different norms and standards on the polluters. The second one, more recent, is based on economic incentive instruments that try to encourage responsible parties to make their activities less polluting. The following paper defines each of these instruments and argues their advantages and disadvantages in order to find a more efficient approach.

The traditional regulatory approach is better known as “Command and Control policies” where governments set limits (norms & standards) on certain pollution sources and apply a strict control on it. According to Harrington & Al. (2004), there are three types of such standards: ambient, emissions, or technology standards. An ambient standard is a regulation on the limit amount a specific pollutant can be rejected in a specific ambient environment. For example, some countries use ambient standards to define the air quality. In France, this standard is called “indice ATMO”, it is calculated each day in every city with more than 100 000 inhabitants. Taking into account the amount of four air pollutants, it helps inform people about the air quality and take the appropriate corrective measures if the rating is too high. This is a kind of indirect regulation as it applies to every emission: industries’ as well as individuals’. Emission standards are much more focused as they determine the amount of emissions discharged by a firm or an industry. By setting this limit, governments impose the companies to reduce their emissions to comply with these standards. However companies are not forced to this and thus can skip the whole process altogether, they do not have any requirement regarding the use of a special technology or something else to reach that goal. This kind of regulation has been used by the European Union to reduce newly produced vehicular CO2 emissions to 130 g/km by 2012. Non-compliance to this standard will lead to the automobile producers getting fined. Sometimes, regulation agents stipulate the type of technology to use in order to comply with the regulatory bodies: this is a technology-based standard. As an example, Sweden imposes the use of catalytic converters on every car since 1989 in order to reduce greenhouse gas emissions. Using this last regulation concept, governments are able to define what and how these regulations work. From the firm’s point of view, it seems fairer as it forces each one to achieve the goal in the same way.

The second economic instrument group is much more based on the market approach using economic incentive policies to motivate pollution reduction strategies. The U.S. Environmental Protection Agency define it as “any instrument that provides continuous inducements, financial or otherwise, to encourage responsible parties to reduce their releases of pollutants or make their product less polluting”. There are many such instruments, we can classify the more common ones into the following categories: environmental taxes, deposit-refund systems, tradable permits and subsidies. The environmental tax follows the “Polluter Pays Principle” where the polluter is required to pay a certain amount per unit of pollution. Such taxes are common in Europe in the form of Ecotaxes on products for example (carbon tax on every IT products in France). The deposit-refund system is a method of creating an incentive to recycle used products. The system charges a certain amount in accordance with the impact of a product on the environment and when this product is returned to be recycled, the surcharge is refunded. It is used in Canada for empty cans and bottles for example. In Europe, more and more incentives are created, certain mobile phone manufacturers reduce the price of a new phone if the consumer gives back his old one. The tradable permits system is based on interactions between polluters themselves. Once the regulator parties have set a number of rules and have determined the amount of pollutants each firm can emit, polluters can buy and sell these permits to each other according to their needs. The fact that these permits to pollute are “transferable” enables the less polluting firms to make profit by selling their non used permits. Another method consists in paying polluters not to pollute. Most OECD countries provide some financial assistance in order to support environmental investment through subsidies. In the form of grants, low-interest loans or tax concessions, it provides assistance to the private sector in pollution reduction incentives. In France, the French Environment and Energy Management Agency (ADEME) under supervision of the French Ministry of Ecology provides financial assistance to many operations with the aim of protecting the environment and managing energy.

Historically, environmental regulation started with the use of regulation standards by governments. Then, more sophisticated approaches were created in order to enable a dynamic efficiency rather than a static one. Decades after the first environmental regulations have passed, policy makers are still facing difficulties to tackle pollution emission. Some regulations have a good track record, others not, but there is still a fundamental question remaining, which is the best approach?

Standards form the basis of a most environmental policies, it defines clearly the limits that a polluter should comply with. The more difficult point is to efficiently define these limits in order to create pollution reduction without stopping the economic growth. As an example if car manufacturers were asked to improve their car emissions to comply with no more than to 50 g/km by 2012, it would completely bring the automotive industry to a halt (today’s requirements are 130g/km). Objectives have to be feasible and cost-effective. What it means is that: the regulations should be strict enough to cause pollution reduction but not too much as it would harm the economy. So, the prime advantage of an efficient Command and Control policy is real pollution emission reduction. If the polluter does not comply, he will pay a fine. However, this approach requires a significant investment from the regulatory bodies. It is very costly to put into practice the control strategy in order to check the compliance and find the violators. Moreover, sometimes regulators collect information about compliance from the polluters’ sources so there is a risk of inaccurate reporting. In a Command and Control (CAC) approach, a regulation is created for each pollutant, it means that it’s even a longer process to control each emission of each firm. In the previous section, we saw that CAC policies can be seen as a fairer example, where they apply to every firm in the same way. Some can argue on that point saying that it does not take into account the difference between firms in terms of needs as well as in terms of localization. In this kind of approach, the government’s involvement is undeniable: everything remains under its decisions, from the elaboration of a regulation to the application and the control of each suspicious process.

The economic incentive policies based on a market approach provide a different strategy which consists in creating incentives to fight pollution and let the polluters answer using their own approach. As a consequence, companies can take action by regulating their global emissions rather than trying to reduce each source of emission. This is well illustrated by the REgional CLean Air Incentives Market (RECLAIM) in the U.S. which states the principle of a bubble: “RECLAIM encloses the facility in an imaginary "bubble”. Rather than regulating each source, AQMD regulates the total pollution in the bubble”. If these policies are properly applied, they will encourage polluters to undertake pollution reduction efforts that are both good for their profitability and good for the environment. Let us use an example. With an environmental tax, the polluter is required to pay a tax on the pollution it emits. If this polluter is a firm, it will have an incentive to reduce its impact on the environment in order to avoid an increase in its product/services price, which can hurt customer satisfaction. Contrary to regulation standards, they can do so using the technology they want. This flexibility and the possibility that a government can use tax revenues to reward good behavior are their core assets. However, like the creation of a fee for regulation standards, the amount of the tax must be well specified in order to reach the optimum tax. To avoid this rather complicated problem, tradable permits do not use such taxes, it is based on the relation between the polluters themselves. This policy can be seen as an alternative to the use of too many taxes. Nevertheless, from an ethical point of view, such a “permit to pollute” is highly criticized. Moreover, it can be seen as a “barrier to entry” making it difficult for new firms to enter the industry (Ison & al., 2002). The tradable permit system showed good results following its application in many countries but its efficiency depends on the market specifics and their behavior. The difficulty occurs at the beginning when allocating the pollution rights to companies, it’s hard to satisfy everyone. One very efficient way to create incentives is the deposit/refund system as it rewards an appropriate behavior immediately. The fact that the consumer is given a refund really stimulates the recycling process but there is still a question of cost effectiveness. Palmer & al. estimate that the implementation of a deposit/refund system costs one-half more than a traditional fee. It requires high administrative costs, and to be effective, the deposit must be high enough to encourage people to get the refund. To finish the review of the positive and negative aspects of this market based approach, let us speak about subsidies. Subsidies are the opposite mechanism of a tax: governments give cash payments in order to develop sustainable systems. One positive point is, contrary to an environmental tax, it rewards not to pollute instead of penalizing. The negative point would be that it can’t reward all the good behaviors because of the importance of its financial costs.

The debate on the efficiency of the two approaches is still going on. There is no “one size fits all” solution. Each case should be analyzed in order to find the correct policy. CAC policies set standards which lead to higher compliance costs and less innovation than economic incentive systems (EIs) but remain the more used for political reasons. In fact, powerful companies prefer CAC policies than IE systems because they think it will lower their costs. As an example, environmental taxes are mainly unpopular because it represents another financial constraint while firms consider that they are already overcharged. Moreover, to induce a change in behavior such a charge must be high enough. While IE systems cause higher costs to firms, CAC policies have higher administrative costs! IE systems require less control operated by the regulator parties, polluters can feel less closely watched. As a consequence, incentives to operate a pollution reduction control on their own will be considered as less restrictive. CAC policies appear to reach objectives quicker than IEs because of their immediate application and the strict control process. Nevertheless, by quick and strict application, CAC can discourage research and development which is a long process. By giving more freedom and flexibility, IE systems provide greater incentives to innovate and as a consequence to develop sustainable systems in the long term. According to the U.S. Environmental Protection Agency, Economic Incentive systems have many advantages compared to Command and Control policies (EPA, 2004). The main reason is that it provides motivation for polluters in order to take initiatives. The EPA also states that IE systems are more likely to fit the environmental problems we face because they target problem in a global approach. Contrary to IE systems, CAC policies are not well suited to control small sources.

On a long term basis, IE systems seem to produce more costs savings in pollution reduction and to stimulate incentives and innovation. The main problem appears to be more political than economical: firms prefer CAC policies because they realize it as a lower cost approach. The environmental economic policy is a constant bargain between experts, regulatory bodies and polluter parties on which are the best policies to apply. “Environmental problems are complex, both in origins and in application. Likewise, today’s markets are sophisticated and dynamic” (Ison & al., 2002). Nowadays, environmental regulation in most countries is a combination of both approaches as each one is important in its own right. The control authority must decide the limits using CAC policies before starting to allocate economic incentives.

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