Using the Market for Cost-Effective Environmental Policy


Courtesy of European Environment Agency (EEA)

Over the decades, Europe has come a long way in improving environmental quality. Andreas Troge (1), commenting on the current lack of action to curb fine particle emissions from diesel vehicles, said ' …. if we had not installed catalytic converters back then (the 1980s), we would have to reduce our driving by 90  % today to get the same air quality'.

This is impressive, and points at effective environmental policy measures in the recent past, as well as at the great societal benefits of achieving environmental objectives. The introduction of catalytic converters in cars, necessary to achieve emission reductions prescribed by EU legislation, was made to happen through a variety of policy measures, including market-based instruments (MBIs). In many environmental areas, however, implementation of environmental regulation shows a deficit, and needs further reinforcing. Market-based instruments (2) will continue to play a role in reducing that deficit.

Environmental measures come with a cost. The older (EU-15) Member States spend 1.8  % of their GDP on environmental protection (3). These costs may rise further in the future, as environmental legislation tightens further. Although technological innovation, learning and economies of scale reduce unit abatement costs, many of the cheapest solutions have already been applied, and marginal abatement costs (additional costs per unit for further pollution abatement) are generally expected to rise in certain areas and sectors (e.g. CEC, 2004a (4); RIVM, 2005  (5)). The ten new Member States spent about 1.6  % of GDP on environmental protection in 2000, four years before their accession to the EU, a higher percentage than in many of the older Member States; and this was expected to rise to 2–3  % in order to comply with the acquis requirements (Eurostat, 2002 (6)).

The implementation deficit and the rising cost of environmental measures call for cost-effective solutions in the short term and further savings through technological innovation in the longer term. Market-based instruments help to reduce environmental costs, because they make optimal use of the diversity of economic activities. Some companies face high abatement costs, some lower costs. MBI can help to implement measures where they are the cheapest, which is favourable for society as a whole. MBI results in prices (7) to which individuals and firms react differently. For some it will be cheaper to reduce the use of the environment than to pay; it will be the opposite for others. Each will look for its own cheapest solution, either pollute and pay, or abate and save, thus securing an overall lowest-cost outcome.

Market-based instruments leave the choice of environmental technique to the firm. In the longer term they have the potential to boost technological innovation and the diffusion of existing techniques, because of the continuous pressure they exert on liable firms to look for cheap solutions. Technological innovation curbs rising abatement costs in the future. This dynamic efficiency potential is a demonstrated advantage over the most common forms of direct regulation that prescribe techniques or establish relative or absolute emission levels, and leave the regulated companies alone after compliance.

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