Literature Review and Conceptual Notes Application of Economic Instruments for Environmental Management: from Theoretical to Practical Constraints Literature Review and Conceptual Notes Ronaldo Seroa da Motta IPEA, Research Institute for Applied Economics Co-ordinator of Environmental Studies Rio de Janeiro, Brazil, seroa@ipea.gov.br   

Pricing Criteria and EI Description Three distinct criteria:  Achievement of the optimal use level: to maximize social welfare achieving an optimum use/pollution level.  Improvement of cost-effectiveness: to minimize social costs at a certain use/pollution target.  Generation of revenue: to raise enough revenue to meet a certain budget requirement.  

Any of the criteria can be set with restrictions based on distributive criteria on their objective functions, such as, ability to pay and minimum free use level. The choice of one of these three criteria is related to first and best conditions and this is not always recognized in their design and implementation Estimation of use and pollution levels and damage functions face technical problems and legal barriers

Spectrum of Policy Instruments with Economic Incentives < - CONTROL ORIENTED >< MARKET ORIENTE D -- > --LITIGATION ----> Regulations & Sanctions Charges, Taxes & Fees Market Creation Final Demand Intervention Liability Legislation General Examples Standards : Government restricts nature and amount of pollution or resource use for individual polluters or resource users. Compliance is monitored and sanctions made (fines, closure, jail terms) for non compliance. Effluent or User Charges charges fee to resource users based on amount of pollution or resource use and nature of receiving medium. Fee is high enough to create incentive to reduce impacts. Tradable Permits establishes a system of tradable permits, auctions or distributes permits, and monitors compli ance. Polluters or Performance Strict Liability Rating : Legislation : The Government polluter or supports a labeling resource user by or performance law is required to rating program that pay any damages requires disclosure to those affected. of environmental Damaged parties information on the collect sett lements final end - use through litigation product. and court system. Performance b ased on adoption of ISO trade permits at 14000 voluntary unregulated guidelines Eco - market prices. labels attached to ‘environmentally friendly’ products.

Cost-saving potentiality Potential cost-savings depend on control cost heterogeneity among polluters/users On location, size, technology, information and managerial skills Cost-saving benefits must be balanced against implementation Institutional changes: different expertise on tax collection and accounting Care with the temptation to reckon on EI revenues to build up the needed institutional capacity (vicious circle)

Environmental targeting and uncertainty Target the immediate source of environmental damage to avoid spillover effects Aggregate targets may vary in spatial terms so as the pricing structure Imperfect information and trial-and-error approach Avoid prices when marginal damage function is steep

Subsidies Environmental subsidies in all forms are widely used Charges will lead to the same control equilibrium level in the short-run In a dynamic perspective may reduce incentives for technological innovation and affect new entries Exemptions and charge differentiation abound, including in the OECD

(cont) For example, in France for agricultural water and in Scandinavia for energy-intense industries in air pollution charges Subsidies are inevitable to trade off environmental and growth targets Cross-subsidies, even when aggregate environmental and revenue targets are met, assure improved equity gains at the expense of efficiency

Revenues and incentives Experiences with EI are dominated by revenue-raising aims and do not fully replace CAC Any change in water relative price affects use level according to agent’s water price and income elasticities.   It is difficult to separate the effect of financing schemes from the charge price incentive.

Some evidence: in France affects more the operation decisions than the control investment ones in Holland charge and control levels have, however, a correlation as high as 70% in Colombia water charges vary with river basin ambient quality targets

Double dividend environmental taxes may be neutral by reducing total tax burden (tax recycling) diverting taxation from “good things” (labour and capital) to “bad things”(degradation). reduced pollution and tax distortions: the double-dividend.  it depends on a solid fiscal system able to make adjustments and also on a good environmental monitoring and regulation enforcement few evidence: already in place for CO2 tax in Scandinavian countries

Market creation When marginal damage cost function is too steep, market creation may be an option It requires certain conditions: 1 – Secure property rights 2 – Low transactions costs 3 – Absence of market power 

sucessful example: USA Sulphur Dioxide Allowance Trading air pollution trade scheme in Santiago failed because of weak institutional legal basis for use rights water markets in some basins in USA failed due to high transaction costs water charges in Chile had problems of secure rights and high transactions

Conclusions choice of an appropriate economic instrument is theoretically complex there are controversy about its effectiveness application of EIs has been to raise revenue in order to fund environmental programs and projects and/or to finance environmental management services Latin America and Caribbean’s experiences followed the OECD pattern

LA experiences showing problems in design and implementation issues, such as:   weak targeting and performance monitoring of environmental goals lack of sound pricing criteria; and poor performance on revenue collection.

Policy Analysis Phase The objective of the environmental policy   Current command-and-control mechanisms Current distortionary fiscal instruments affecting the environmental goals Causes and sources of the environmental problem addressed by the policy aims Environmental damage, control and opportunity cost assessments

Instrument Analysis Phase Theoretical analysis   Past experiences Institutional barriers Legal barriers Public perception

Instrument Development Phase Monetary evaluation   Legal evaluation Simulation of revenue generation and distribution Economic and social impact assessment Compensatory measures Institutional arrangements/Implementation planning Public awareness and debate Performance indicators