This chapter reviews several of the attributes of incentive-based strategies for managing the environment. From the perspective of economics, pollution is an output that occurs outside of normal market transactions. Termed an “externality,” it has little or no cost to the source but may impose significant costs on other economic actors. How best to get sources to control their pollution is an issue that has been studied closely by economists and policy analysts.
One means of control is to rely on private negotiations between those who bear the costs of pollution and the sources of pollution. If several conditions are satisfied, such negotiations can lead to an optimal level of pollution control in which the full costs of pollution are taken into account in the decision process of the source. (Coase. 1960). One condition is that the sources and victims do not engage in strategic behavior. Another condition is that individuals who are harmed by pollution and sources can negotiate without any transaction costs (such as personal time or the need for third-party involvement). The final condition is that sources and victims are fully informed as to risks and harms that may occur. Although the assumption of no strategic behavior may be reasonable in many cases, costless transactions may never be a realistic assumption. The more parties who are harmed and the more geographically dispersed these parties are, the higher the transaction costs are likely to be. Likewise, it is unrealistic to assume that victims of pollution are as fully informed about risks as are the sources.
The existence of environmental legislation reflects the fact that negotiations between victims and sources of pollution cannot be relied upon as a means of control for most pollution problems. EPA’s governing legislation uses various approaches to set environmental goals. Under some of the laws, the goal is to adequately protect public health and the environment without explicitly considering costs. In other cases, the governing statutes instruct EPA to take costs into account in protecting public health and the environment or to set goals that balance cost, health and environmental considerations.
The governing environmental statutes have varying opportunities and limitations with respect to the mechanisms that are available for achieving environmental goals. In the traditional regulatory approach, EPA often specifies requirements for different types of sources (factories, vehicles, fuels, etc). The regulations may impose limitations on the amount of discharge, the technology used to control pollution, the inputs that may be used, or characteristics of the outputs that are produced.
Market-based or incentive approaches, by contrast, provide rewards for reducing pollution (and, conversely, assign penalties for releasing pollution). The rewards may or may not be financial. In contrast to the traditional regulatory approach, an incentive-based regulatory strategy gives sources great flexibility in selecting both the type and magnitude of their response and gives them incentives to develop new and cheaper strategies and technologies to control pollution.
Depending upon the characteristics of the sources of pollution and the damages (see Table 3-1), some tools of environmental management are likely to be more cost-effective than are others. Cost-effective tools achieve environmental goals for the least cost. Other criteria such as fairness, political acceptability, stimulus for innovation and technological improvement, and enforceability also could be used in place of, or in conjunction with, cost effectiveness.
The following sections describe alternative means for managing the environment and the circumstances under which one mechanism is likely to perform better than another tool.
|Table 3-1. Considerations for Selecting Regulatory Instruments|
|Characteristics of the sources of pollution |
· Are the costs of control known with certainty? If not, how great is the uncertainty?
· Is the technology of pollution control static, or is it likely to change over time?
· Can the quantity of pollution from each source be measured (or approximated) easily?
· How many sources are there for each pollutant?
· Are incremental control costs similar for different sources, or is there considerable variation?
Characteristics of the damage caused by pollution
· Does a unit of pollution from each source have the same impact on health and the environment, regardless of where it is released?
· Are the impacts on health and the environment known with certainty? If not, how great is the uncertainty?
· What are the major sources of uncertainty? What is known regarding the effect of pollution on environmental quality, exposures, physical effects, or the economic valuation of effects?
· How many parties are experiencing damage from pollution?
· Is it critical to control pollution within narrow limits to achieve environmental goals, or is the damage caused by pollution such that there is a continuum of effects from less serious to more serious, with no obvious unacceptable level and no obvious safe level of pollution?