Dr. Sindhu. J.

Nair

Professor, BITD

INTRODUCTION

Economists argue that environmental assets, because they are free or under priced, tend to be overused or
abused, thereby resulting in environmental damage.

Economic instruments seek to correct this situation by

setting a price for environmental damage or

creating ownership rights to environmental goods.

Some environmental resources–such as timber, fish and minerals–are bought and sold in the market.

But their price usually does not reflect the true cost of obtaining them because it does not include the cost of
the environmental damage that may ensue from their extraction and processing.

Other environmental resources such as the atmosphere and waterways are public or social goods that are not
individually owned, or bought and sold, and do not have any market price.

Economists argue that there is a strong tendency for people to overexploit and degrade these common
property resources.

When individuals or firms make decisions about production, consumption and investment, they generally do
not consider the environmental or social consequences because they seldom have to pay the cost of those
consequences.

(For example, a company that discharges its effluent into a river affects fishermen and other users of the
water downstream.

Yet the costs suffered by downstream users are not charged to the company nor built into the price of the
company's products.

The market does not take account of these environmental costs and they do not appear in the company’s
account books.
These ‘spillover effects’ of doing business have been called ‘externalities’ by economists, indicating that they
are external to normal market transactions.

The presence of these externalities represents a failure of the market to protect the environment.

Environmentalists seek to address this market failure by adjusting prices so that the person making/buying
the goods or services causing the external cost is obliged to pay for it.

These are called

Economic Instruments

I CLASS

Economic Instruments :-

This can be done by means of a

tax : (on those who purchase coal for use in their industries )

for example, tax on coal mining to cover the medical expenses of those miners who are suffering from black
lung disease.

Economic Instruments :-

The additional costs may also provide an incentive to the coal industry to find ways to prevent miners from
getting this disease.

a. There are other ways of internalizing environmental costs without relying on the pricing mechanism.

A. to require a company to take its water downstream from its discharge point.

B. to take notice of external costs by prescribing limits to what can be discharged or emitted.

C. companies will choose to pay for cleaning up their wastes.

Incentives motivates desired behavior, and disincentives discourage behavior which is not desired.

A) An incentive can be any inducement which is specifically intended to incite or motivate governments, local
people, to use the resources sustainable and equitably share the benefits arising from the use of resources.
Eg : subsidies, or grants

b) A disincentive can be any inducement or mechanism designed to discourage governments, local people, or
corporations from depleting the environmental resources.

Water cess, cpcb rules,,,,,,

Disncentives include
a) taxes,
b) fines, and Penalties of other types (which are usually administered through legislation)
c) public opinion or peer pressure (the use of which is far more subtle).

Together, incentives and disincentives provide the carrot and the stick for motivating behavior that will
support

implementation of the sustainable technology.

II CLASS

The Commonwealth Government identifies two main types of economic instruments for providing an incentive to
use resources sustainably:

1.Price-based measures : user charges and subsidies to internalize environmental costs and benefits.

2.Rights-based measures

‘create rights to use environmental resources or to pollute the environment, up to a pre-determined limit, and
allowing these rights to be traded’.

Price-based Measures

1. Price-based Measures

The price-based measures aimed at protecting the environment are referred to as economic instruments for
environment protection.

They include:
a) Subsidies

Subsidies are payments from the government to the producer which effectively reduce the price of goods or
services, and therefore encourage their sale.

Subsidies include tax deductions and rebates. (to the producer in procuring the raw materials)

The government can also provide grants for particular programs and projects, including environmental
projects such as the National Soil Conservation Program.

Another example is grants for environmental technology.

Charges
A charge can be considered as a ‘price’ that is paid for polluting the environment.

Charges include:
1.effluent charges, that are based on the content and quantity of a firm’s discharges into the air, water, or
sewerage system;
2.user charges that are charged for using a resource such as timber or for being provided with a service such
as garbage collection;

3.product charges, charges on packaging that are used to discourage disposal or encourage recycling;

4.sales and excise taxes rebate that give environmentally friendly products a price advantage over polluting
products

Efficiency of price based measures

In the case of price-based measures, their effectiveness will depend on whether the prices or charges are high
enough.

In most countries, charges are too low to provide an incentive; instead, they merely act to redistribute money
from the polluter to the government.

Governments can use the money raised in this way for environmental protection, such as collective treatment
and research into pollution control technologies; but often they do not.

CLASS III

II

Rights-based Measures

2. Rights-based Measures

Some economists argue that environmental degradation occurs because of incomplete ownership of rights to
use valuable resources.

In situations where the environment cannot be privately owned, access rights or user rights can be owned.

The idea of rights-based measures is that if people have a right to the use or pollute the natural resources,
they will consider the longer term and manage those resources sustainable.

1. Tradable pollution rights (Emissions Trading)

Tradable pollution rights are an alternative to pollution charges which allow firms to trade the right to emit
specific pollutants.

(VIDEO 1)
Emissions Trading

The idea is that some firms can reduce their pollution more cheaply than others.

Those firms that can most afford to reduce their emissions are able to sell their excess rights or permits to
those companies that find it expensive to reduce their emissions.

The two main ways of initially allocating tradable pollution rights are usually referred to as

grandfathering and

auctioning.

1. Grandfathering VIDEO 2

involves allocating permits to firms on the basis of their past emissions.

Firms that polluted more in the past would have larger shares.

Emissions grandfathering maintains that prior emissions increase future emission entitlements.

2. Auctioning VIDEO 3

Alternatively a pre-specified number of pollution allowances can be auctioned off to polluters.

 In either case the total allocation will be based on the estimated capacity of the environment to take a certain
amount of pollution.

GRANDFATHERING is a provision in which an old rule continues to apply to some existing situations while
a new rule will apply to all future cases.

If the permit that a company is allocated or has bought is less than their actual emissions then such firms
would have to either try and reduce their emissions or buy extra permits.

Similarly they would be able to sell those they don’t need if they reduce their emissions below what they are
permitted to emit.

Demerits :-

1. Grandfathering favors existing firms and disadvantage for new firms wanting to set up.

2. In order to establish itself, a new firm must buy up enough pollution rights to cover its emissions.

Auctioning means that

each firm has to bear additional costs just to operate as they have to buy permits at auction to emit gases they had
previously been emitting for nothing.

This is especially hard for firms that are competing with overseas firms not having to bear these costs.

IV CLASS

A major drawback of emissions trading is that :-

it can cause some neighborhoods to get a lot of more pollution than others because the companies in their
area are buying up permits rather than reducing their pollution.

Also emissions trading tends to protect very polluting or dirty industries by allowing them to buy emission
rights rather than meet environmental standards.

Emission trading….

In this way, trading can reduce the pressure on companies to reduce their emissions by changing their
production processes and attaining a cleaner environment.

The introduction of emissions trading as a mechanism for greenhouse gas reductions has the potential to
enable similar "phony" reductions.

The most obvious is the trading of emissions credits with Russia and other eastern European countries that
are in economic decline.
Russia’s economic decline has meant that its carbon dioxide emissions have decreased by some 30% below
1990 levels.

Now countries such as the US and Japan are looking to buy the right to those emissions which Russia is
unable to use so that they don’t have to reduce their own emissions.

This will not benefit the environment or help to reduce the global emissions of greenhouse gases in the long-
term because the reductions that would have occurred without emissions trading are now being used by
affluent countries to avoid their own emissions reductions.

They are referred to as "hot air" or "phantom" emissions reductions.

(2) Cap-and-Trade System

A cap-and-trade system (VIDEO 4) sets an aggregate rather than an individual cap on emissions, and tradable
allowances take the form of individual quota shares to the aggregate emissions cap.

Elements of a Successful Cap-and-Trade System

1. Determine an overall maximum level of emissions (the "cap").

2. Assign polluters an individual pollution quota or allowance, usually based on emissions levels in some
baseline year; the sum of these allowances is equal to the desired level of emissions.

Elements of a Successful Cap-and-Trade System

3. Let these allowances be tradable to some degree.

4. Require new firms to buy allowances from existing firms.

5. Create a market institution that minimizes the transaction cost of trades.

6. Monitor and enforce sanctions against those that pollute above and beyond their allowance, so firms have
an incentive to buy allowances rather than freely pollute.

7. Maintain policy stability over time so, firms are willing to buy permits knowing that standards will not be
lifted in the future.

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