EnvJustice

Economic, regulatory and voluntary instruments

Governments can act through different public policy instruments in order to support behavioural change towards sustainability. Instruments can vary according to the degree of public intervention: from the most intense (regulatory instruments, also referred to as ‘command-and-control’ mechanisms) to a mix of incentives and disincentives (economic instruments) and to the least intense (educative/voluntary instruments). Literature often refers to ‘stick’ (regulation) as a coercive mean of intervention, or ‘carrot’ (economic instruments) as a set of incentives/disincentives, or ‘sermons’ (educative/voluntary instruments) as a mean to inform society of the advantages or disadvantages of given behaviours. However, this distinction might be misleading, because on one hand, economic instruments can also be used as ‘stick’; on the other hand, the margin between regulatory, economic and educative instruments is blurred and in many cases, the adopted policy is a result of a combination of different approaches.

Price-based economic instruments

Economic instruments are widely used in Western policy-making. One of the most common categorisations of economic instruments distinguishes price-based instruments and quantity-based instruments. Price-based economic instruments stand upon the concept of price signals: consumers will be oriented towards sustainable products, because their price is lower than that of polluting products. We can differentiate between positive (incentives) and negative (disincentives) price-based instruments: subsidies and tax reductions (or exemptions) are positive instruments, because they reduce costs of green goods; on the contrary, ecological taxation is an example of negative instrument, because it affects negatively prices of polluting goods. A more practical example of positive price-based mechanisms is government subsidies to invest in renewable energy technologies (e.g. solar panels) at households and at business levels. With regards to negative price-based economic instruments, the typical example is carbon tax: it applies to all forms of energy production from conventional sources (oil, coal, gas), which are responsible for CO₂ emissions. Another example would be a ‘natural capital depletion tax’.

Quantity-based economic instruments

The second main category of economic instruments is quantity-based mechanisms. The main principle behind quantity-based economic instruments is that governments quantify a level of allowed emissions and create an artificial market of pollution permits, based upon a price set by the scarcity of emission allowances. This mechanism makes it expensive to pollute, because heavily polluting ‘participating entities’ have to pay more to buy emission allowances. The system offers also incentives to reduce emissions, because better performing ‘participating entities’ can make profits by selling exceeding emission allowances. Quantity-based mechanisms are also known as cap-and-trade systems. This was applied in the United States to sulphur dioxide emissions, similar to proposals for carbon trade. An existing case of cap-and-trade systems is the European Union Emission Trading Scheme, which applies to energy producers and energy-intensive industries at European level. Another interesting example, but rather difficult to implement, concerns the Personal Carbon Allowances: in theory, it might be possible to extend the emission market to individuals, so that people are required to buy or sell emissions according to the quantity of emissions released in their everyday life (Parag and Strickland, 2009).

Other examples

Finally, there are also other policy interventions that do not adequately fit in the two above-mentioned categories. Let us take the example of public direct investments, which can also be considered to a certain extent as an economic instrument: in particular green public procurements (state buying) can be an important instrument in the pursuit of sustainability in the public sector; as well as public–private partnerships used to invest in green infrastructure. Other policy instruments reflect the interaction between regulatory and economic instruments: for example, environmental liability of companies generally comes from regulatory laws but companies are incentivised not to pollute in order to avoid payment of the fine (economic disincentive). On the contrary, nuclear energy firms are exempted from liability for nuclear accidents (as TEPCO after the Fukushima accidents of 2011), and they are not forced to pay for the unavoidable costs of long-term disposal of nuclear waste. Reversal of these regulations would increase their costs. Eco-labelling is another example of combination of regulatory and economic instruments: on the basis of the well-known A to G rating for domestic appliances (regulatory instrument), governments can sponsor subsidies or tax advantages for high-efficient goods in exchange of low-efficient ones.

Negative aspects and the way forward

One of the aspects that need further analysis relates to negative consequences of any given economic instrument. Positive price–based instruments require considerable efforts from government budgets and, besides their effectiveness in the short term, they are not economically sustainable in the long term. Negative price-based instruments, on the contrary, might entail additional production costs for companies, which consequently pass costs through the final consumers. Effects of higher final prices are the loss of competitiveness for companies with activities on the international market, therefore affecting employment negatively. Quantity-based instruments may also produce negative social problems: increasing prices of basic goods (notably energy prices), unemployment, and uneven distribution of costs and benefits of the environmental policies across society.

The debate on instrument choice (regulatory, economic or voluntary) generally tends to focus on economic cost and environmental effectiveness of the policy instrument supported. Nowadays, it is recognised that voluntary agreements are the least environmentally effective measure (as it has been the case for car industry’s average fleet standards); however, some educative and informative measures are still necessary to build up a general consensus about sustainability policies. For instance, fair trade rests on persuasion. Neoliberal economists consider regulatory instruments too invasive regarding market freedom; nevertheless very strong regulation is socially well accepted in cases like the prohibition of asbestos, of tobacco smoking in public places and in other instances. Generally, economic instruments are assumed as the most cost-effective measures to reduce negative externalities at the least cost; nonetheless, market-based instruments can exacerbate social inequalities. Current and future policy instruments fostering sustainability should look at balances between different policy instruments, including compensation measures for vulnerable groups.

References

Parag, Y. and Strickland, D. (2009) ‘Personal carbon budgeting: what people need to know, learn and have in order to manage and live within a carbon budget, and the policies that could support them?’, June 2009, UKERC.

For further reading:

Bemelmans-Videc M.-L., Rist R. C., Vedung, E. (1998) Carrots, Sticks & Sermons: Policy instruments and their evaluation, Transaction Publisher, New Brunswick (USA) and London (UK).

Driesen D. (2006) Economic instruments for sustainable development, in B. J. Richardson and S. Wood, Environmental law for sustainability, Hart publishing, pp. 343-380.

Greenspan Bell R. (2003) Choosing Environmental Policy Instruments in the Real World, OECD Headquarters, Paris, 17-18 March 2003.

Panayotou T. (1994) Economic Instruments for environmental management and sustainable development, United Nations Environment Programme (UNEP), Environment and Economics Unit.

This glossary entry is based on a contribution by Marco Grancagnolo 

EJOLT glossary editors: Hali Healy, Sylvia Lorek and Beatriz Rodríguez-Labajos