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Economic Instruments For Controlling Air Pollution Economics Essay


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Air pollution as a menace is known to one and all. Air pollution has numerous disadvantages, which are both on a micro and a macro scale. On micro scale, it causes health problems like respiratory diseases and degradation of immediate environment. On macro scale, it leads to greenhouse problem, ozone layer depletion, climatic discrepancies etc. Various economic, scientific, technological and industrial measures are being taken to check this growing problem.

Economics plays a very important role in checking air pollution. Various economic measures for controlling it are -

Tradable credits - This measure includes allowing firms a maximum level of polluting permit surpassing which they will be liable to fines. These credits are transferable. These will either lead to firms turning to more eco-friendly production measures if it amounts to decrease on cost or paying other firms to decrease their carbon emissions.

Incentive Pricing - This method includes introduction of such economic measures that makes the polluter himself pay for the pollution caused by him.

Tax imposition [1] - This is imposition of taxes on polluting units. Taxing polluting units will have an increased per unit cost of production. A producer can avert this situation of rise in unit cost by reducing the level of output or substituting the eco friendly input for polluting input.

Subsidies - This measure amounts to subsidising eco-friendly measures such as wind mills, hydro power plants, allowances to research of green technology etc.

Direct regulation - This is use of legal machinery to place curbs on polluters by passing legislations and rulings.

All these measures whether they are market based or command and control types are related with the theories of 'polluter pays [2] ' and precautionary measures.

The principle of 'polluter pays' was adopted as an environmental policy for checking air pollution by the Organisation of Economic Cooperation and Development [3] (OECD) in 1972. According to this principle, the external costs of pollution shall be borne by the polluter. The precautionary principle recognises the existence of uncertainty and seeks to avoid irreversible damages via imposition of a safety margin into the policy.


Air pollution [4] is the presence of solid, liquid or gaseous particles in the atmosphere, which are not generally present, or are present in higher concentration and have no beneficial effect. They are injurious to human beings or other living creatures or plants or environment.


There are broadly two sources of air pollution - natural and manmade.

Natural sources [5] of air pollution include fog, dust, salt spray, gases from springs, fissures and cracks in the earth, volcanoes producing ash, gas, fumes and smoke, smoke from forest fires, and pollens from various plants and weeds.

Man made causes of air pollution include pollution from industries, vehicular pollution, domestic pollution etc. Industrial pollution includes all the works related to production and consumption of energy in any form. For example, it includes use of oil, coal, gas and electricity. Pollution from motor vehicles is also source of air pollution. It has become an issue simply because of the steady increase both in the number of the vehicles in use and the distance travelled by each vehicle each year. Number of registered motor vehicles increased from .306 million in 1951 to 58.863 million in 2002 [6] . It is the fastest growing source of CO2 emissions.


Air pollution has many negative effects associated to it. Among many others, they are greenhouse effect, acid rain and effect on health. It has harmful economic effects as well.

Greenhouse effect - Air pollution is due to the large scale burning of fossil fuels (coal, petroleum etc.) in industries and for transportation. This leads to greenhouse effect which acts as an instrument in increasing earth's temperature. Among the various greenhouse gases like carbon dioxide (CO2), Ozone (O3), methane (CH4), nitrous oxide (N2O), carbon dioxide independently plays an important role in creating greenhouse effect, which is emitted due to the burning of fossil fuels.

Acid rain - Acid rain may be defined as the increasing level of acidity in rain water. This phenomenon is observed mainly near places where there are coal-fired power plants, smelting facilities and large scale automobile usage. It can create serious environmental damage. For example, British industries emitting harmful gases have caused substantial harm to fishery in the lakes and rivers of Sweden and Norway [7] .

Effect on health - Air pollution creates serious impact on health. It gives rise to various diseases like asthma, lung cancer, impaired vision and other bronchial and respiratory diseases. Many recent studies bear out the cancer risk from diesel fumes; children and the infirm are known to be especially vulnerable. The impact of air pollution on health is widespread. A World Bank 2000 study conducted for six cities in developing countries found that pollution from diesel vehicles(vehicular air pollution) are responsible for 79 per cent of the total health cost from the transport sector [8] .

Economic effects -

Air pollution leads to livestock depletion. Canaries, ducks, cattle, sheep, horses, and pigs grow sick and die due to the pollution. They breathe air pollutants or eat feed or grass that has been contaminated by the residues of the various pollutants. For example, arsenic produced during copper smelting process, molybdenum produced during steel making process. Pollutants lower the egg yield of chickens, milk yield of cows and makes sheep to grow a thinner coat of wool.

Property is also damaged by polluted air. Steel, iron, copper, nickel, brass, tin, lead and aluminium, all corrode faster in the areas where the concentration of air pollutants is high. Pollutants affect fabrics. Smog causes rubber tyres to crack.

Acid rain caused due to air pollution decreases farm yield apart from egg and milk production as stated above. Degradation of fertile land takes place.


Air pollution is a problem, both at the national and the global level. Thus, controlling measures, policies and laws regarding its control are to be formulated at both national and global level.

There are two principles evolved to control air pollution. They are firstly, the 'polluter pays principle' (PPP) and secondly, the precautionary principle.

Polluter Pays Principle (PPP) -

Basis - If consumption or production decisions of one economic unit enters into the utility or production function of other economic units without any compensation, negative externalities arise. When a firm discharges its emissions into the atmosphere, they result in harm/damage to society. The firm treats the environment as if it were a free good or an unpaid factor of production: it ignores the cost of degradation of the environment [9] .

Meaning - The basic theory of PPP is that the price of a good or service shall fully reflect its total cost of production which also includes the cost of all the resources used. It will also include the use of natural resources like air used for emission of wastes [10] . Thus, in a way, polluter shall bear the external cost of pollution caused by him. This gives an incentive to the polluter (producer/consumer) to lower its pollution level at least to the level where the marginal cost of pollution reduction is equal to the marginal cost of the damage caused by such pollution [11] .

The interpretation of PPP would change its colour slightly with changes in the environmental policies of a country. For example, if there is an acceptable pollution limit line drawn, and the polluter has to pay only when his pollution level exceeds the acceptable pollution level, and not for the environmental damage caused by the discharge acceptable pollution. Thus, in this case PPP can be interpreted to grants polluters a de facto right to discharge the acceptable level of effluent without paying any fine.

Problems [12] - A difficulty attached with the implementation of the PPP is that the environmental sources are freely and widely available and thus stand a chance of over exploitation in lack of any proper pricing measure for them. The PPP seeks to transfer the costs of pollution to the polluters, but to obtain effective results proper pricing of environmental sources has to be done.

Another problem is of a coordinated international approach. If one country subsidises environment friendly measures for its industries, and others do not, the industries of the subsidising country would have an advantage over others in the market.

The concept of 'polluter pays' has been encouraged at both international and national levels.

International level - The Organisation of Economic Cooperation and Development (OECD) adopted in 1972 the 'polluter pays' principle as a principle of environment policy. The United Nations Conference on Environment and Development (UNCED), Earth Summit, 1992 held at Rio de Janeiro also endorse the application of the 'polluter pays' principle [13] .

National level - The Policy Statement for Abatement of Pollution, issued by the Ministry of Environment and Forests in February 1992, recommends the 'polluter pays' principle. In its Judgement dated 21 August, 1996 on the Public Interest Writ Petition (c) No. 914 of 1991 filed by the Vellore Citizens Welfare Forum, the Supreme Court endorsed the 'polluter pays' principle [14] .

Precautionary principle

Basis - If polluting substances are being released into the environment at a high rate or in cases where human health damage effects are likely, or in situations where uncertainty is great, rather than treating the problem after it becomes big, precautions should be taken. The age old saying of 'prevention is better than cure' comes into picture.

Meaning - The precautionary principle recognises the existence of uncertainty and seeks to avoid irreversible damages via the imposition of a safety margin into the policy. It insists on taking care while setting emission standards, and emphasise on the prevention of pollution through source reduction measures (e.g. changing, modifying production processes or products ) rather than the sole reliance on end of pipe treatments (e.g. effluent treating) [15] .

Problems - This principle involves greater fund transfer to research of cleaner technology thereby overlooking the present needs of immediate pollution control through effluent treatment etc. Another problem associated with this principle is that setting up of standard of pollution will leave no incentive with the firm to further lower the pollution caused by him once he reaches the standardised level set.

The precautionary principle has been appreciated and promoted at both national and international level.

International level - The Organisation of Economic Cooperation and Development (OECD) adopted in 1972 the precautionary principle as a principle of environment policy. The United Nations Conference on Environment and Development (UNCED), Earth Summit, 1992 held at Rio de Janeiro also endorse the application of the precautionary principle [16] .

National level - In its Judgement dated 21 August, 1996 on the Public Interest Writ Petition (c) No. 914 of 1991 filed by the Vellore Citizens Welfare Forum, the Supreme Court endorsed the precautionary principle [17] .


There are two approaches to the problem of air pollution. One is by the way of market based instruments and the other is the approach of command and control measures.

Market based instruments

Market based instrument approach to environmental policy makes use of market place, by modifying market signals in order to induce environmentally more friendly behaviour. These include tradable permits, incentive pricing and subsidies.

Tradable permits - For tradable or marketable permits, first an acceptable level of pollution is determined. Permits are then issued for the level of emissions with respect to different pollutants up to the allowable limits. Any polluter achieving lower pollution than the acceptable limit possesses a credit. This credit can be traded in the market for money or any other consideration [18] . This will give an incentive to polluters to pollute less. If the polluter has to bear more costs for abating pollution than buying credits, he will buy credits thereby giving incentive to other firms to pollute less. This trade need not be between different polluters (external trading). It can be between different sources within the same firm (internal trading). The result would be the same, as the firm will gain by concentrating abatement in its low cost sources and concentrating permits in its high cost sources [19] .

Certain arguable questions raised by environmentalists regarding the tradable permits are, whether environmental quality is sacrificed under a tradable permits system, and whether it is morally right to permit pollution even for a price.

Incentive Pricing - Economic incentives can be provided to the polluter so as to make him bear the costs of his pollution. The method of making the polluter himself bear the costs which he had earlier passed on to the society is known as internalisation. Some economists argue that when private costs of the polluter involves the costs of the social damage on account of the pollution caused by him, he will willingly try to reduce his pollution level [20] . This method will be successful even when the polluter keeps on polluting, as the extra cost paid by him will be utilised to finance the control pollution measures by some other body.

Subsidies [21] - This method is comparatively more effective because it provides some incentive to the polluter to adhere to the policies or laws formulated. Subsidies can be of the form of tax reduction, supplemental funds, easy availability of loans and grants. Subsidies on initial investment i.e. loans for new projects has a disadvantage over tax reduction as it may discourage the use of other pollution control measures. For example, in some cases air pollution can be better controlled by switching from polluting to non polluting or less polluting fuels like from coal to gas rather than capital expenditure on some pollution control device. In case of vehicular pollution, subsidies can be granted to promote more efficient vehicles or as the Earth Summit on Environment and Sustainable Development (1992), Agenda 21 suggests the government to promote mass transport systems, instead of highly wasteful personal transport.

Command and Control (CAC) instruments

This measure includes setting up of environmental standards (e.g. for air quality) which are enforced with the help of legislation without the aid of market-based incentives. It involves control methods such as direct regulation and tax imposition.

The CAC instruments are argued to be on a lower footing compared to market based instruments. The reasons given for this are -

1. Under the CAC approach, government must set up a regulatory body to know about the emission standards of the polluter. This involves exhausting of resources whereas this information can be directly obtained by the polluter himself.

2. Under CAC, polluter has to achieve a given standard which is subject usually to some consideration about the type of technology adopted. But the control is not concentrated in the sources that may be best effective in decreasing the pollution. If such a process was available under CAC, it would have helped to reduce the overall costs of compliance with the standards set by CAC.

We can conclude about the veracity of these statements by dwelling deeper into the CAC approach for controlling air pollution.

Direct regulation [22] - Direct regulation involves legal recourse in the form of any law or regulation. There are certain guidelines to be kept in mind while formulating any direct regulation for putting a check on air pollution. Laws should not demand very high level of pollution control or fail to provide any financial burdens; else they will not be very effective. Also, laws should be such that they do not involve undertaking of high economic loses by a large number of people because then it will be difficult to enforce it. Anti pollution laws are not properly observed when some amount of financial sacrifice is needed [23] . Enforcement problems arise when there are inadequate detection and policing systems. Another problem with direct regulation is that even if similar regulations are present in different countries, if the method adopted for their formation is not the same, there may be discrepancies in the law, which may place nations on different environmental stands even after having similar regulations. An instance of such a discrepancy is India, where the government does not undertake evaluation and reanalysis of cost estimates that the refineries churn out. Other governments crosscheck the cost claims of industry and refineries first. Thus the regulations imposed on our refinery sector though apparently similar in their outlook are different in terms of the environmental standards provided by them [24] .

Example of a direct regulation for control of air pollution is the decision of the Supreme Court of India in April 1999, making it mandatory for the automobile industry to meet with the Euro I norms within 30 days. It gave the automobile industry another 9 months to meet with the Euro II standards [25] .

Direct regulations may be also be applied to collect data regarding pollution from the polluters themselves, thereby releasing the burden on the government to perform surveys and checks. To take an example [26] , in US, after the Bhopal Gas tragedy, the Emergency Planning and Community Right to Know Act, 1986 was passed. This act made it mandatory for industries to disclose the names of hazardous chemicals they were dealing with, quantities of such chemicals they were releasing into the atmosphere, and the possible dangers. In 1990 the Clean Air Act was amended and required a range of industries to disclose worst case scenarios and the preventive measures in place. The US Environment Protection Agency (EPA) moved to post all the information on the internet in order to make it more widely accessible. Making the information publically available can also help controlling the pollution. People earlier using products production of whose tends to pollute environment a lot, may change their preferences when they come to know about the harmful environmental effects of the products used by them.

Tax imposition - The idea of a pollution tax was first put forward by the British economist Pigou, in 1920, who suggested that polluters should face a tax based upon the estimated damage caused by their pollution emissions. Such charges were known as 'Pigovian taxes' [27] .

Tax on input is shall be imposed when pollution takes place at production level (e.g. use of coal in copper smelting plant) and tax on output shall be imposed when pollution takes place at consumption level (e.g. use of petrol in cars). Tax on input would ultimately lead the producers to adopt more environmental friendly techniques. For example, if a tax on carbon fuels is imposed where coal would attract higher tax than oil which in turn would attract higher tax than natural gas. Then, in this case of industries using these resources like those involved in power production are charged indirectly. Thus electricity sector would alter its fuel mix to a less carbon polluting form. In this way, pollution can be controlled at production end. Tax on polluting output would increase the market price of the product and thereby decrease the level of demand and hence the production. Taxing polluting unit will have an increased per unit cost of production [28] .

There are certain products and sources of pollution which can be charged at both input and output level for improving air quality. For example, tax can be imposed on vehicular pollution at both input and output level, which would include higher tax rate on fuel inefficient vehicles, higher tax rate on polluting vehicles and on fuels not meeting the desired environmental norms [29] .

Advantage of taxes over other kinds of direct regulations like setting emission standards is that since taxes would be administered by the government's existing tax framework, there is a lower chance of their evasion compared to that for fixed emission standards which are policed via irregular on site inspections. Once the pollution level is set, the firms have no incentive for further reduction of emissions below this level, whereas in the taxing framework, incentive to keep on reducing the emissions is always present because the lower the emissions the lower the tax which polluter would be liable to pay. This in turn gives an incentive to the firms to allot funds for research and development of new pollution abating technology [30] .

Tax upon one pollutant may reduce the emission of the associated pollutant. For example, if a firm switches to non fossil fuels from fossil fuels due to a tax imposition of carbon emission, then emission of other pollutants like sulphur associated with fossil fuels will also decrease which is not possible when the policy of fixed emission standards is applied.

Taxes have disadvantages as well. They are argued to be distributionally regressive [31] . To meet with the increase in cost because of tax imposition, the producer will increase the price of its product, thereby distributing his increased liability among the consumers. This has a negative effect of charging the poor in a proportionately higher manner than the rich. There are some international problems [32] associated with tax imposition. If one country imposes taxes on its industries then they will be at a disadvantage when compared to foreign competitors. If all countries agree to impose taxes, then for equity, tax in each country has to be different which would be arguable. Industries in those countries which do not sign any international pollution tax treaty will be at an advantage.


Air pollution takes place by virtue of both natural and manmade causes. It has various harmful effects which include health hazards, greenhouse effect and acid rain. It has many negative economic effects as well. Polluter pays principle and precautionary principle are the two principles devised to control air pollution. They have been recognised and encouraged at both national and international level. The measures under these principles are categorised as market based instruments which rely on market changes to control air pollution and command and control instruments which rely on executive and judicial powers to control air pollution. The methods applied at the grass root level under market based instruments are tradable permits, incentive pricing and giving subsidies, and those applied under command and control instruments are direct regulation and tax imposition. All of these economic measures help in averting the problem of air pollution.

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