Economic Instruments

Session Objectives:

• Identify economic instruments for specific environmental issues

• Identify constraints on application of economic instruments

Agenda

• What is an economic instrument?

• Why use economic instrument?

• Major economic instruments: overview

• Limitations of economic instruments

• Discussions

What is an Economic Instrument?

• Environmental policy or measure based on market mechanisms

• Internalize environmental values in individuals’ decision-making– full-cost pricing

– price = marginal private cost + marginal env’tal cost

• Objective: to change human behavior

• May use economic valuation as a basis

Why Use Economic Instruments?

• SD requires change of human behavior• Laws may change behavior, but legal systems are

weak/costly in many countries• Education may change behavior, but its alone may

not be adequate• Economic instruments provide incentives to which

people respond• Economic instruments can help raise funds for

nature conservation

Benefits of Full-Cost Pricing

• Let market price reflect scarcity & externality, encourage saving & efficiency

• Eliminate subsidies to reduce government fiscal burden

• Resultant behavior change can save or postpone additional inputs & expenditures

• Fiscal surplus can be used to improve the environment & expand social services

Types of Economic Instruments

• Property rights

• Market creation

• Fiscal instruments

• Charge systems

• Financial instruments

• Liability systems

• Performance bonds

• Deposit-refund systems

Property Rights

• Unclear, insecure property rights lead to short-term behavior, long-term resource cost (user cost)

• Property rights need to be well-defined, secure, exclusive, and transferable

• Can be private, collective, or state ownership• This instrument can be complemented by other

instruments to control externalities from the property

Sub-types of Property Rights

• Ownership: land titles. Water rights, mining rights

• Use rights (physical division): stewardship, licensing, concession/bidding, turfs

• Development rights: patents, prospecting rights

Market Creation

• Difficult to assign property rights over certain environmental resources (clean air)

• May allocate use rights while ensuring a total aggregate use to the desired level

• Allow trading of use rights

Sub-types of Market Creation

• Tradable emission/ effluent permits

• Tradable catch quotas

• Tradable development quotas/rights

• Tradable water shares

• Tradable resource shares

• Tradable land permits

• Tradable offsets/ credits

Fiscal Instruments

• Use taxes to internalize negative externalities into private costs

• Use subsidies to internalize positive externalities into private benefits

– Env’tal tax = marginal env’tal cost– Env’tal subsidy = marginal env’tal benefit

Sub-types of Fiscal Instruments

• Pollution taxes– effluent taxes

– emission taxes

• Inputs taxes• Product taxes• Export taxes• Import tariffs• Tax differentiation

• Royalties & resource taxes

• Investment tax credits• Accelerated

depreciation• Subsidies• Property taxes• Capital gains taxes

Charge Systems

• Often confused with fiscal instruments

• Charges for the use of resources, facilities, and services

• Taxes (fiscal instruments) are a means of raising government revenue

Sub-types of Charge Systems

• Pollution charges• User charges• Betterment charges• Impact fees• Access fees

• Road tolls Administrative charges

• Resource protection charges

• Collection charges

Financial Instruments

• Similar to fiscal instruments• Fiscal instruments are part of the government

budget• Financial instruments are outside of government

budget• Usual sources of funds for financial instruments:

foreign aid, foreign debt, debt-for-nature swaps• To support projects/activities that generate positive

externalities

Sub-types of Financial Instruments

• Financial subsidies• Soft loans• Grants• Location/relocation

incentives• Subsidized interest

• Hard currency at below equilibrium exchange rate

• Revolving funds• Sectoral funds• Ecofunds/env’tal fund

s• Green funds

Liability Systems

• Legal liability

– natural resource damage

– environmental damage

– property damage

– damage to human health or loss of life

– noncompliance to env’tal laws & regulations

– non-payment to due taxes, fees, or charges

• Liability insurance

• Enforcement incentives

Bonds & Deposit-Refund Systems

• Charge in advance for potential damages

• Shift the responsibility for controlling pollution, monitoring, and enforcement to individual producers & consumers

• Env’tal performance bonds

• Land reclamation bonds

• Waste delivery bonds

• Env’tal accident bonds

• Deposit-refund systems

• Forest management bonds

Other Instruments

• Administrative measures

• Consumer education

• Disclosure of information on producers

• Self-regulation by producers’ associations

Caveats

• Experience mainly from industrial countries, though there are lessons to learn

• Developing country experience not well documented, and country circumstances vary, though possible to implement

• Many countries have used administrative measures for years, how to introduce economic instruments without causing disruptions?

• Often used to raise revenues, not change behavior