Market based approaches for environmental regulation
By Tigmanshi
There are three major agencies through which the economy co-ordinates:
- The market,
- The government, and
- The communities.
All the three have their own mechanism through which they regulate the economy. The communities work through obligations and commitments. The governments use coercion or force in the form of policies to monitor economy. Markets work through incentives. These can be positive and negative depending on the type of exchange.
The two agencies — market and governments have always been at logger heads when it comes to economy co-ordination, which essentially means that it is all about command Vs. Incentives.
The free market radicals believe that it is only the market that can bring the forces of demand and supply into equilibrium because markets capture important information about social costs and benefits of all goods and services of all economic agents which the governments will never come to know that can be used to produce goods and services that are desired by the society. This generates efficiency and profitability in the economy helping it to prosper. Planning, as claimed by governments and authorities on the other hand helps reduce inequality of income, control inflation, produce socially optimal goods & services, and helps keep the balance of payment in check.
Historically, it has been seen, as in the case of countries like, Chile, Bolivia, Argentina, etc., that free markets have helped them emerge out of depressions and economic crises. However, empirically, free markets fail in two cases:
- In case of externality
- In case of public goods
Externality is the by-product of a transaction that is experienced by a third party who is not involved in the transaction. Thus we can understand it by saying that the good or service produced does not cover the extra cost or benefit that is incurred by the third party indirectly involved in the transaction. Here, the actual price of the product is higher or lower than what the consumers have to pay in order to consume that product depending on the type of externality that is generated. For example, polluters of air.
In the case of public goods, that are non-excludable and non-rival in nature, markets fail to generate cost of consumption from the consumers thus creating losses. In simpler terms, people can free ride on others’ paying for the service. For example, a common park.
When markets fail, role of government comes into play. The government can regulate the market in such a manner that the extra costs that the society has to bear in case of externalities and public goods that do not generate profit thus disincentivizing private players are both taken care of.
There are two ways in which the government regulates the producers when it comes to externalities generated:
- Command and Control methods:
· BACT (best available control technology) — this is the same as mentioned earlier, where the government orders the companies to use one standardized technology for fighting pollution. However this has certain drawbacks. This is insensitive to costs that a firm incurs in order to install the technology which can be harmful in terms of profit for the firm. It has the danger of disincentivizing the firms to research and innovate by ‘locking in’ the technology. This also discourages improvement in other fields such as raw material choices, efficiency improvements, etc. This comes as a heavy fall on the relatively newer firms that are low on budget.
- Market based approaches:
· Taxation — This involves attaching a fee to each unit of emission. This is a incentive based approach where enough freedom is given to the firms to innovate in order to be taxed less. Here, the government does not override the market, and instead uses the mode of incentives to control unwanted externalities.
· Tradeable allowance — Under this method, the government imposes certain limits of the total amount of emissions that can be generated into air. The idea is that each emitter can buy allowances that are transferable to emit pollutants. This incentivizes the producers to control their emission through research and innovation. This will allow those firms who can emit cheaply to sell their allowance to other firms in order to maximize profit. This helps the government to push the polluters towards greener resources.
· Deposit-refund system — This is like a refund system. This method lets the firms report their emission with the government on which they have to pay fees. Once they have treated the waste and properly disposed it, they get a refund on the same. This incentivizes the firms to reduce waste generation and properly treat their waste.
· Information-disclosure — In this method, the government makes the companies and firms report to the public about the environmental characteristics of the products they produce. The idea is that the consumers will be sensitive to environment and their health and therefore switch to more environment-friendly products. This will again act like an incentive for the producers to produce environment-friendly products.
Thus in general the market based approaches address many issues that the command and control based method have.
Examples of such methods can be: (Stewart, 1992)
- The Pinelands development — The issue here was that the state of New Jersey did not want excessive development of the forested pinelands. In order to regulate development, the state used the method of private property, where they issued ‘transferrable development rights’ or TDRs. The idea was to give the dwellers of the land property rights which they could use to prohibit development on their respective land. In return the government provides them with TDRs that they can sell to those who wish to develop in other parts of Pineland. The government in this manner has facilitated exchange and also protected the indigenous rights of the people. Thus, the total amount of development is capped and people too get a say in the development process.
There are other such examples where market based instruments have worked such as carbon tax on fuel which incentivizes use of public transport while also generating revenue for the government.
Thus the government can undertake ‘command and control’ tools, which is the use of force or ‘market-based mechanisms’, which is the use of incentives’ system. The command and control system directs the producers and consumers to act in a particular manner using force. On the other hand, a market based system would be imposing taxation in order to disincentive the producers to produce the commodity that is generating externality. This also gives them incentive to reduce the use of polluter and leaves enough space for them to experiment and innovate for them to come up with better technologies in future. A market based system is a better system as it not only leaves room for innovation but also gives the producers and consumers freedom.
Bibliography
Stewart, R. B. (1992). Models for Environmental Regulation: Central Planning Versus Market-Based Approaches. Boston College ENviornmental Affairs law Review , 547.
Other references:
Pal, Rajesh. (2018). Market Success and Market Failure. https://www.researchgate.net/publication/322925699_Market_Success_and_Market_Failure
