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Market-Based Instruments in Practice

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Markets and the Environment

Abstract

We have now seen how environmental degradation and excessive resource extraction often result from absent or incomplete markets and how the best solutions to these kinds of market failures may be market principles themselves. Now we look at some examples of how market-based policies have been used in the real world.

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Reference

  1. If you are interested in reading more, some comprehensive studies of market-based policies in the real world include Charles E. Kolstad and Jody Freeman, eds., Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience (New York: Oxford University Press, 2007); Robert N. Stavins, “Experience with Market-Based Environmental Policy Instruments,” in Karl-Göran Mäler and Jeffrey R. Vincent, eds., Handbook of Environmental Economics, Vol. 1 (Amsterdam: Elsevier Science B.V., 2003), 355–435; Thomas Sterner, Policy Instruments for Environmental and Natural Resource Management (Washington, DC: Resources for the Future, 2003), 363; and Theodore Panayotou, Instruments of Change: Motivating and Financing Sustainable Development (London: Earthscan Publications, Ltd., 1998).

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  2. Congress anticipated this problem in the 1977 Clean Air Act Amendments, which declared that significant capital investments at existing plants, designed to extend their lifetimes, would trigger the stringent federal regulation that applied to new sources. The so-called New Source Review process entailed a costly survey of planned investments that might trigger those regulatory standards. However, enforcing this provision has bedeviled subsequent administrations and stirred up fierce opposition from electric power plants. The line between routine maintenance and “significant” upgrades has been difficult to establish. As a result, electric utilities have been reluctant to make investments that would improve the operating efficiency of their plants. At the same time, the EPA has been largely unsuccessful in forcing utilities that made past investments to install new control equipment.

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  3. Many of the details about the allowance trading program created by the 1990 Clean Air Act are taken from the definitive overview provided by A. Denny Ellerman, Paul J. Joskow, Richard Schmalensee, Juan-Pablo Montero, and Elizabeth M. Bailey, Markets for Clean Air: The U.S. Acid Rain Program (New York: Cambridge University Press, 2000).

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  4. Richard Schmalensee and Robert N. Stavins, “The SO2 Allowance Trading System: The Ironic History of a Grand Policy Experiment,” Journal of Economic Perspectives 27: 103–122 (2013).

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  6. Nathaniel O. Keohane, “Cost Savings from Allowance Trading in the 1990 Clean Air Act,” in Charles E. Kolstad and Jody Freeman, eds., Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience (New York: Oxford University Press, 2007), 194–229.

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  7. See Nathaniel O. Keohane, “Environmental Policy and the Choice of Abatement Technique: Evidence from Coal-Fired Power Plants,” Yale University mimeo available at www.som.yale.edu/faculty/nok4/files/papers/scrubbers.pdf (on adoption decisions); and David Popp, “Pollution Control Innovations and the Clean Air Act of 1990,” Journal of Policy Analysis and Management 22 (4): 641–660 (Fall 2003) (on patents and technological innovation).

  8. In fact, a small fraction—roughly 3 percent—of each year’s allowances were auctioned off by the EPA. This provision was included in the trading program to overcome concerns that giving away all of the allowances would make it possible for the incumbent firms to hoard their allowances, driving up the price for firms that wanted to enter. But in a sign of the political power of the regulated industry, the allowance revenue was credited to the electric utilities that had given up their allowances to be auctioned rather than being retained by the government.

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  10. The geographic distribution of pollution under the allowance trading program is also discussed by Ellerman and his colleagues in Chapter 5 of Markets for Clean Air (see note 3).

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  11. Recall from our discussion of fisheries in Chapter 7 that fishing to MSY is economic but not biological overfishing; thus the TACs would have to be lower than their current levels to induce the efficient level of fishing effort.

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  12. At the program’s inception, IFQs represented a right to an absolute amount of fish rather than a percentage of the TAC. But this policy led to total shares that exceeded the TAC in several fisheries soon after the program was implemented. The government had to buy back almost 16 metric tons of shares, at significant cost. Issuing quotas as a percentage of the TAC avoids causing this problem in the future.

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  13. Cindy Chu, “Thirty Years Later: The Global Growth of ITQs and Their Influence on Stock Status in Marine Fisheries,” Fish and Fisheries 10: 217–230 (2009).

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  14. For a recent overview of carbon pricing systems around the world, see World Bank, State and Trends of Carbon Pricing 2014 (Washington, DC: The World Bank, 2014). Detailed country-level case studies of emission trading systems, prepared jointly by the International Emission Trading Association and the Environmental Defense Fund, can be found online at http://www.ieta.org/worldscarbonmarkets.

  15. See John H. Annala, “New Zealand’s ITQ System: Have the First Eight Years Been a Success or a Failure?” Reviews in Fish Biology and Fisheries 6: 43–62 (1996).

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  16. The excluded thirty stocks covered areas fished lightly for only a few species, not suspected to be at serious risk of overfishing. See John H. Annala, Report from the Fishery Assessment Plenary, May 1994: Stock Assessments and Yield Estimates (Wellington, NZ: MAF Fisheries Greta Point, 1994), quoted in Annala, “New Zealand’s ITQ System,” 47.

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  17. All data on market performance, including quota and lease prices and market activity, are taken from Richard G. Newell, James N. Sanchirico, and Suzi Kerr, “Fishing Quota Markets,” Journal of Environmental Economics and Management 49(3): 437–462 (2005).

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  18. Note that this equity concern is distinct from a potential efficiency concern. If some market participants grow large enough that they can affect the market price of quotas, then efficiency will suffer, just as in any market where firms have market power. Recall our discussion of market failures at the end of Chapter 5.

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  19. See James Sanchirico and Richard Newell, “Catching Market Efficiencies,” Resources 150: 8–11 (2003).

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  20. See Clement and Associates, New Zealand Commercial Fisheries: The Guide to the Quota Management System (Tauranga, NZ: Clement & Associates, 1997); and P. Major, “Individual Transferable Quotas and Quota Management Systems: A Perspective from the New Zealand Experience,” in K. L. Gimbel, ed., Limiting Access to Marine Fisheries: Keeping the Focus on Conservation (Washington, DC: Center for Marine Conservation and World Wildlife Fund, 1994), 98–106.

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  21. These fees covered more than 80 percent of the program’s cost in 1994–1995. See Suzanne Iudicello, Michael Weber, and Robert Wieland, Fish, Markets and Fishermen: The Economics of Overfishing (Washington, DC: Island Press, 1999).

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  22. See Iudicello et al. Fish, Markets and Fishermen, 105.

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  23. See Christopher M. Dewees, “Effects of Individual Quota Systems on New Zealand and British Columbia Fisheries,” Ecological Applications 8(1): S133–S138 (1998).

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  27. More precisely, price elasticity measures the percentage change in demand that results from a 1 percent increase in price.

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  32. The information in this section is summarized from Karen A. Fisher-Vanden and Sheila M. Olmstead, “Moving Pollution Trading from Air to Water: Potential, Problems and Prognosis,” Journal of Economic Perspectives 27(1): 147–172 (2013).

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  33. See George Van Houtven, Ross Loomis, Justin Baker, Robert Beach, and Sara Casey, “Nutrient Credit Trading for the Chesapeake Bay: An Economic Study,” Report prepared for the Chesapeake Bay Commission, May 2012, RTI International, Research Triangle Park, NC.

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  34. Robert Repetto, Roger C. Dower, Robin Jenkins, and Jacqueline Geoghegan, Green Fees: How a Tax Shift Can Work for the Environment and the Economy (Washington, DC: World Resources Institute, 1992).

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  35. Skumatz Economic Research Associates, Inc., “Pay as You Throw (PAYT) in the U.S.: 2006 Update and Analyses,” Final report to the EPA Office of Solid Waste, December 30, 2006, Superior, CO, available at www.epa.gov/osw/conserve/tools/payt/pdf/sera06.pdf, accessed February 21, 2015.

  36. Don Fullerton and Thomas C. Kinnaman, “Household Responses to Pricing Garbage by the Bag,” American Economic Review 86(4): 971–984 (1996).

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  37. See Robin R. Jenkins, Salvador A. Martinez, Karen Palmer, and Michael J. Podolsky, “The Determinants of Household Recycling: A Material-Specific Analysis of Recycling Program Features and Unit Pricing,” Journal of Environmental Economics and Management 45: 294–318 (2003); and Ju-Chin Huang, John M. Halstead, and Shanna B. Saunders, “Managing Municipal Solid Waste with Unit-Based Pricing: Policy Effects and Responsiveness to Pricing,” Land Economics 87(4): 645–660 (2011).

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  38. The Brazilian example is summarized from Kenneth M. Chomitz, “Transferable Development Rights and Forest Protection: An Exploratory Analysis,” International Regional Science Review 27(3): 348–373 (2004).

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  39. See Virginia McConnell and Margaret Walls, “U.S. Experience with Transferable Development Rights,” Review of Environmental Economics and Policy 3(2): 288–303 (2009); and Virginia McConnell, Margaret Walls, and Elizabeth Kopits, “Zoning, Transferable Development Rights, and the Density of Development,” Journal of Urban Economics 59: 440–457 (2009).

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  40. Figures for 1993–2000 from National Research Council, Compensating for Wetland Losses under the Clean Water Act (Washington, DC: National Academy Press, 2001). Figures on wetland mitigation banks in 2001 and 2005 taken from Jessica Wilkinson and Jared Thompson, 2005 Status Report on Compensatory Mitigation in the United States (Washington, DC: Environmental Law Institute, 2006). Credit prices from Richard R. Rogoski, “Liquid Assets: New Breed of Bankers Deal with Wetlands,” Triangle Business Journal, September 8, 2006.

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  41. The discussion of conservation banking draws on a report titled “Mitigation Banking as an Endangered Species Conservation Tool” (Washington, DC: Environmental Defense Fund, 1999), downloaded from www.environmentaldefense.org/documents/146_mb.PDF#search=%22ESA%20endangered%20species%20banking%22.

  42. See Christian Langpap and Joe Kerkvliet, “Endangered Species Conservation on Private Land: Assessing the Effectiveness of Habitat Conservation Plans,” Journal of Environmental Economics and Management 64: 1–15 (2012).

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  43. This phenomenon is known colloquially as “shoot, shovel, and shut up.” For example, among the owners of more than 400 forest plots in the U.S. Southeast, the average age of timber harvest (the average rotation, discussed in Chapter 7) falls from nearly 70 years if there are no endangered red-cockaded woodpeckers nearby, to nearly half that length if there are 25 colonies within 25 miles of the logging site. Because the woodpeckers prefer old-growth pine, it appears as if landowners seek to avoid the costs of federal regulation under the ESA by discouraging woodpeckers from settling in their trees. See Dean Lueck and Jeffrey Michael, “Preemptive Habitat Destruction Under the Endangered Species Act,” Journal of Law and Economics 46: 27–60 (2003). Broader studies of the impacts of species listing under the ESA have also suggested that listing can be harmful to species recovery, unless substantial funds are invested in recovery efforts. See Paul J. Ferraro, Craig McIntosh, and Monica Ospina, “The Effectiveness of the U.S. Endangered Species Act: An Econometric Analysis Using Matching Methods,” Journal of Environmental Economics and Management 54: 245–261 (2007).

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  44. See Kelly Chinners Reiss, Erica Hernandez, and Mark T. Brown, An Evaluation of the Effectiveness of Mitigation Banking in Florida: Ecological Success and Compliance with Permit Conditions. Florida Department of Environmental Protection #WM881. Gainesville, FL (2007), available at http://www.dep.state.fl.us/water/wetlands/docs/mitigation/Final_Report.pdf, accessed February 22, 2015; and Rebecca L. Kihslinger, “Success of Wetlands Mitigation Projects,” National Wetlands Newsletter 30(2): 14–16 (2008).

Further Reading

  • Burtraw, Dallas, Alan Krupnick, Erin Mansur, David Austin, and Deirdre Farrell. 1998. “Costs and Benefits of Reducing Air Pollutants Related to Acid Rain,” Contemporary Economic Policy 16(4): 379–400.

    Article  Google Scholar 

  • Ellerman, A. Denny, Frank J. Convery, and Christian de Perthuis. 2010. Pricing Carbon: The European Union Emissions Trading Scheme, Cambridge University Press, New York.

    Google Scholar 

  • Ellerman, A. Denny, Paul J. Joskow, Richard Schmalensee, Juan-Pablo Montero, and Elizabeth M. Bailey. 2000. Markets for Clean Air: The U.S. Acid Rain Program, Cambridge University Press, New York.

    Google Scholar 

  • Fisher-Vanden, Karen A., and Sheila M. Olmstead. 2013. “Moving Pollution Trading from Air to Water: Potential, Problems and Prognosis,” Journal of Economic Perspectives 27(1): 147–172.

    Article  Google Scholar 

  • Freeman, Jody, and Charles D. Kolstad. 2007. Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience, Oxford University Press, New York.

    Google Scholar 

  • Huang, Ju-Chin, John M. Halstead, and Shanna B. Saunders. 2011. “Managing Municipal Solid Waste with Unit-Based Pricing: Policy Effects and Responsiveness to Pricing,” Land Economics 87(4): 645–660.

    Article  Google Scholar 

  • Iudicello, Suzanne, Michael Weber, and Robert Wieland. 1999. Fish, Markets and Fishermen: The Economics of Overfishing, Island Press, Washington, DC.

    Google Scholar 

  • Keohane, Nathaniel O. 2007. “Cost Savings from Allowance Trading in the 1990 Clean Air Act,” in Charles E. Kolstad and Jody Freeman, eds., Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience, Oxford University Press, New York, 194–229.

    Google Scholar 

  • Langpap, Christian, and Joe Kerkvliet. 2012. “Endangered Species Conservation on Private Land: Assessing the Effectiveness of Habitat Conservation Plans,” Journal of Environmental Economics and Management 64: 1–15.

    Article  Google Scholar 

  • Mansur, Erin T., and Sheila M. Olmstead. 2012. “The Value of Scarce Water: Measuring the Inefficiency of Municipal Regulations,” Journal of Urban Economics 71: 332–346.

    Article  Google Scholar 

  • McConnell, Virginia, and Margaret Walls. 2009. “U.S. Experience with Transferable Development Rights,” Review of Environmental Economics and Policy 3(2): 288–303.

    Article  Google Scholar 

  • Newell, Richard G., James N. Sanchirico, and Suzi Kerr. 2005. “Fishing Quota Markets,” Journal of Environmental Economics and Management 49(3): 437–462.

    Article  Google Scholar 

  • Popp, David. 2003. “Pollution Control Innovations and the Clean Air Act of 1990,” Journal of Policy Analysis and Management 22(4): 641–660.

    Article  Google Scholar 

  • Sanchirico, James, and Richard Newell. 2003. “Catching Market Efficiencies,” Resources 150: 8–11.

    Google Scholar 

  • Schmalensee, Richard, and Robert N. Stavins. 2013. “The SO2 Allowance Trading System: The Ironic History of a Grand Policy Experiment,” Journal of Economic Perspectives 27: 103–122.

    Article  Google Scholar 

  • Stavins, Robert N. 2003. “Experience with Market-Based Environmental Policy Instruments,” in Karl-Göran Mäler and Jeffrey R. Vincent, eds., Handbook of Environmental Economics, Vol. 1, Elsevier Science B.V., Amsterdam, 355–435.

    Google Scholar 

  • Sterner, Thomas. 2003. Policy Instruments for Environmental and Natural Resource Management, Resources for the Future, Washington, DC., 363.

    Google Scholar 

  • World Bank Group. 2014. State and Trends of Carbon Pricing 2014, World Bank, Washington, DC. Available at http://documents.worldbank.org/curated/en/2014/05/19572833/state-trends-carbon-pricing-2014.

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Authors
  1. Nathaniel O. Keohane
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  2. Sheila M. Olmstead
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© 2016 Nathaniel O. Keohane and Sheila M. Olmstead

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Keohane, N.O., Olmstead, S.M. (2016). Market-Based Instruments in Practice. In: Markets and the Environment. Island Press, Washington, DC. https://doi.org/10.5822/978-1-61091-608-0_10

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