How Can Using a Combination of Policy Tools Be More Efficient Than Using One Exclusively?
Abstruse
Environmental policy is made in a context of both market failure and authorities failure. On the 1 hand, leaving environmental protection to the free market, relying on notions of corporate social responsibility and altruistic consumer and shareholder preferences, will not deliver optimal results. On the other manus, nationalizing the delivery of environmental protection is likely to fail because nation states rarely have the depth and quality of information required to instruct all the relevant agents to make appropriate decisions. Thus, as for many areas of policy, appropriate models of environmental intervention will lie between these two extremes. While it is incommunicable to specify full general rules concerning the precise class of intervention, in part considering the type of intervention depends upon value judgements, this paper sets out some of the considerations that are particular to environmental policy, and explores several principles for policy design, including information, coordination, and chief–amanuensis issues, with a particular focus on the international context.
I. Introduction
Over the class of the twentieth century, the economical borders of the state have sporadically expanded and contracted equally a consequence of war and according to the influence of unlike political philosophies, ideologies, and prevailing value judgements. Prior to the First Earth War, the state largely played a 'nightwatchman' function, providing basic functions such equally defence and police force and social club (Helm, 1986). Yet, government interest in the economy has climbed to record highs in contempo years, with the state playing a more comprehensive role in providing social security, education, physical and mental health, and in other resources-allocation decisions.
Most recently, the global fiscal crisis has led to yet further expansion of the country, with nationalizations of financial institutions, the bail-outs of the automotive sector in the United States, and a coordinated fiscal stimulus from G20 nations amounting to 1.2 per cent of their Gross domestic product (Bowen and Stern, 2010). A further relevant development has been the trend towards so-called 'country commercialism'. For instance, the 13 largest oil companies are now controlled by governments (Bremmer, 2009), with the profits often invested past sovereign wealth funds which deliver both financial returns and political influence. The rise of China, with its numerous land-owned enterprises, serves as another powerful example of the increasing trend towards state capitalism.
In Western democracies, the recent country expansion following the fiscal crises is intended to exist temporary, and, indeed, a contraction of the land is imminent, given significantly weaker public balance sheets. All major political parties in the U.k. are anticipating severe cuts in spending over the next few years, if not for longer. In this context, a re-evaluation of public spending priorities, including on environmental spending, is both inevitable and necessary. In the UK, civil servants are reportedly preparing for budget cuts past examining records from the 1920s when Sir Eric Geddes cutting public spending by 25 per cent. ane
This expansion and contraction of the state has significant implications for environmental policy, raising questions about the appropriate scope and role for government in protecting the surroundings. This issue of the Oxford Review considers topics relevant to the realistic pattern of environmental policy in the context of this shifting relationship between the market place and the state. The consequence places stiff emphasis on accounting for both 'market failure' and 'government failure', and the contributions include considerations of the role of governments and markets in downturns and periods of economic growth (Alex Bowen and Nicholas Stern), the possibility of ecology provision past the complimentary marketplace (Forest Reinhardt and Robert Stavins), the function of government-created environmental markets (Michael Hanemann), the design of policy to spur ecology innovation (Richard Newell), the challenges in determining appropriate environmental prices (Simon Dietz and Samuel Fankhauser), and the critical need to address regime failure (Robert Hahn and David Anthoff, and Dieter Helm) when designing ecology policy. While many of the papers in this Review focus on climate-change policy, other environmental problems are as well pressing. 2 According to Rockström et al. (2009), biodiversity continues to be lost at an estimated rate of over 100 species per million species per year, compared to a background extinction rate of 0.i–one species per 1000000 species of marine life and 0.2–0.5 for mammals. 3 Depletion of renewable resources, such as the earth'south fisheries, and the calibration of humanity'due south affect on the nitrogen and phosphorous cycles are also crusade for concern ( Rockström et al., 2009).
This paper addresses the pattern of environmental policy with a focus on delineating the roles of the state and the market place. The next section provides a brief general history of the shifting borders of the state and provides a highly stylized taxonomy of state intervention, before because the specific implications for environmental policy. Section III considers the extent to which firms and consumers might voluntarily internalize ecology externalities, before assessing the effectiveness of government-created markets (such as emissions trading) to address environmental problems. Section 4 outlines a realistic ready of expectations of government in solving environmental issues, given the inevitable political economy constraints and challenging uncertainties, and seeks to delineate an inevitably imperfect but businesslike role for government in harnessing firms to deliver more than efficient ecology outcomes. Section Five considers the corresponding roles of nation states and the private sector within the international context, including their evolving relationships with international financial institutions. Section Half dozen concludes.
Ii. Shifting economic borders and environmental policy
Approaches to environmental protection, similar other policy areas, reflect the prevailing value judgements almost the office and size of the state. We start with a history on the function of the land in full general (department II(i)) then consider a uncomplicated taxonomy of government intervention (department II(ii)) earlier specifically applying this theory to environmental policy (section Ii(iii)).
(i) The economical borders of the country over time
There has been a striking increase in the country, every bit measured by authorities spending, 4 over the course of the twentieth century, from around x–20 per cent in 1900 to effectually 40 per cent at the first of the twenty-start century, every bit shown in Effigy i. 5 The story is characterized by ii potent increases in government spending during the Kickoff and 2d Globe Wars, when the rapid mobilization of capital and labour was necessarily coordinated past strong and purposeful governments. In both cases, while state interest in the economy declined rapidly following the end of the wars, on neither occasion did information technology render to sometime levels.
Figure 1
Britain and US authorities spending since 1900
Figure i
Great britain and The states government spending since 1900
During the 1950s and 1960s there was broad confidence in the ability of governments to deliver straight on public programmes, with a shared focus on reconstruction and nation-edifice. In the UK, guided by memories of weak government during the Neat Depression, major industries were nationalized and the welfare land was established following the Beveridge Report (Beveridge, 1942). Cathay and India began their v-year plans, the Bretton Woods institutions were established, and 'planning', rather than 'prices', was the dominant paradigm for coordinating economic activity. As in other areas, environmental policy tended towards 'command-and-control' interventions, rather than setting prices and allowing individuals and firms to respond. 6
While the land continued to abound over the 1970s, the revival of monetarist theory began to provide growing intellectual opposition to increasing enlargement. More than chiefly, while economic growth had financed the increasing public sector in the 1950s and 1960s, growth faltered in the 1970s with the two oil shocks and the plummet of the Bretton Wood system. These weather condition ushered Margaret Thatcher into power in the UK in 1969, and Ronald Reagan in the US in 1970, with a corresponding alter in political philosophy. In due grade, this would also bring changes to environmental policy with the creation of ecology markets, seven such equally the United States' acid rain markets in sulphur dioxide (SO2) and nitrogen oxides (NOx) following the 1990 Amendments to the Clean Air Act. 8
Over the last decade, the left-leaning authorities in the UK has enlarged the state, and has further extended its reach following the global financial crisis which served as a reminder that asset markets are field of study to booms and busts and are non self-regulating. 9 The crunch has also created doubts virtually marketplace-based approaches to ecology problems. At the international level, climate-modify policy appears to be moving from being predominantly market-based, relying on systems such as the Clean Evolution Mechanism (Hepburn, 2007), to a mixed organisation which includes a role for national planning, represented by the focus on 'nationally appropriate mitigation actions' (NAMAs) for developing countries, and the actions in the Copenhagen Accord (UN FCCC, 2009). At the European level, carbon markets and market-based renewables obligations coexist with more direct interventions on free energy efficiency and renewable feed-in tariffs (Helm, 2010), and the Eu has taken a relatively directed approach to the award of subsidies for carbon capture and storage plants.
(ii) A general taxonomy of state intervention
The theoretical case for the 'gratuitous market place' is typically based either on the notion that markets instrumentally produce better outcomes than land intervention, or that costless markets are valuable in themselves considering they relate closely to, and support, intrinsically valuable political freedoms. We will address the instrumental arguments and refer the reader elsewhere for a discussion of the ideological arguments for gratuitous markets. 10
Proponents of the view that markets generate better outcomes have relied upon either the neo-classical notion of perfect competition and the theorems of welfare economics (Arrow, 1951; Debreu, 1951) or the Austrian tradition (Hayek, 1948; von Mises, 1936; Schumpeter, 1934, 1942) which stresses the evolutionary and dynamic nature of markets and the critical function of prices in communicating information and assuasive private agents and firms to self-organize within a complex adaptive economic system.
To put this into context, the degree of state involvement in delivering social outcomes (such as environmental protection) might exist considered to be on a spectrum running from 'free market' at one cease, to 'nationalized delivery' at the other cease:
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costless market: no government interest; individuals and firms voluntarily acquire information on externalities and voluntarily and altruistically internalize those externalities;
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data provision: government assumes the office of aggregating and disseminating information well-nigh externalities and their shadow prices, but does nothing more;
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moral suasion: government provides information and may even seek to persuade people and firms to alter their preferences and objectives. 11 In its all-time class, this might constitute a form of 'authorities by give-and-take'. Another recently pop, but some would argue more than sinister, notion is that government might influence people's decisions by 'soft paternalism' or nudging people's decisions past conscientious design of the 'choice architecture' (Thaler and Sunstein, 2003);
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economy-wide relative prices: authorities determines the appropriate cost or quantity of the social adept or externality (due east.g. carbon dioxide (CO2) emissions, And then2 emissions, water effluent, biodiversity) and implements policy to correct relative prices (east.g. economic system-wide taxes, trading schemes, etc.);
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output-based intervention: authorities specifies output standards for specific sectors or firms (e.chiliad. CO2/MW standards), only does not require the use of any item method to evangelize those standards;
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input- or technology-based intervention: regime specifies or encourages or requires firms to employ particular technologies or inputs (e.g. And then2 scrubbers), either through explicit regulation or through taxes or subsidies;
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projection-level intervention: government specifies or encourages particular projects to occur, through subsidy or other fiscal (e.1000. balance sheet) support (due east.g. EU carbon capture and storage (CCS) programme);
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state capitalism: country-owned enterprises follow guidance given past their (government) shareholder; some flexibility for implementation may exist retained if targets are expressed and political incentives put in place, merely often executives are given straight instructions;
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nationalized delivery: government finances and delivers on environmental protection directly though central government departments.
For the environment, unlike other areas of economic activity, relying on the 'free market' or on 'information provision' is highly unlikely to deliver satisfactory outcomes because firms accept inadequate incentives to internalize externalities without government intervention (run into section Three). At the other extreme, there are some sectors of the economic system in which straight government delivery may be advisable—the armed services is by and large run direct by government departments (even if some duties are outsourced to military contractors), and a cracking bargain of infrastructure is provided directly by governments, reflecting the need for planning and coordination in infrastructure at the regional, national, or international levels. Indeed, state provision may be preferable if decentralization to the market would create risks of incoherent and uncoordinated outcomes. All the same, state provision may also entail greater politicization of operational decisions (and hence lower economic efficiency), and may require a great bargain of information that is oftentimes unavailable. Furthermore, nationalizing industries and removing competition undermines the evolutionary dynamic in the economy that generates diversity and wealth (Hayek, 1948; Helm, 1986). 12
For many policy bug, the impossibility of a 'complimentary market place' approach and the inefficiency of 'nationalized commitment' implies a part for government in the middle of the spectrum. While it is plainly impossible to specify whatsoever general rule as to the appropriate point in the spectrum, several more physical general insights on the role of the land are bachelor.
First, the greater the information advantage (disadvantage) of the decentralized market over the centralized state, the more (less) policy should simply focus on 'getting the prices correct' and the more (less) the appropriate intervention volition lie towards the top of the list above. Oftentimes, prices can serve every bit powerful coordinating device, considering they transmit data so efficiently. However, this also causes bug if prices are transmitting the incorrect information because markets are distorted in some way.
Second, the greater the need for a coordinated vision and planning to provide the relevant public goods, as for instance with complex national transport or energy investment, the more the type of intervention is probable to be towards the bottom of the list. For instance, the Chinese communist state has arguably been able to evangelize ship and energy infrastructure more reliably over the last decade than Western economies, where multi-political party democracies pb to bug in providing a long-term credible vision, and where a greater protection of individual rights generates delays or issues with planning permissions.
Third, the greater the likelihood and severity of principal–amanuensis bug (Stiglitz, 1987) in government, the more likely the appropriate intervention is to be towards the top of the list, and vice versa. For instance, where government department chiefs seek to maximize something other than net social welfare (for instance, the size of their hierarchy), authorities interventions are probable to be inefficient. Similarly, where civil servants or regime teams are peculiarly susceptible to capture by individual interests, policy is unlikely to provide a level playing field and efficient results. Principal–agent bug besides ascend in the individual sector. Where the connexion between managing director rewards and long-term shareholder value is loose or severed, information technology is unlikely that the market will generate socially-beneficial outcomes, fifty-fifty in the absence of other market failures.
Fourth, organizational structure and competence besides matter. A regime intervention conducted past a high-calibre, well-performance team able to acquire the requisite information, perform suitable analysis, and advisedly and explicitly balance the competing considerations in the public interest, rather than pretending that at that place are no trade-offs, will be more likely to succeed. In contrast, interventions by a department without the appropriate skills or organizational construction are likely to neglect. If government failure is likely, information technology must be asked whether the consequences will be ameliorate or worse than simply living with the market failure, without the government intervention.
In sum, markets and governments always fail to some caste, so the suitable approach for a given policy problem will, in addition to reflecting specific value judgements not addressed in this newspaper, strike a balance between the problems of marketplace failure on the ane hand (run across department Iii) and government failure on the other manus (run into section Four).
(3) Environmental policy and the economic borders of the country
What do these broader insights almost the part of the land generally imply for specific environmental interventions? Even though there are no full general rules well-nigh land intervention, are there 'special' features of specific environmental policies that warrant particular attention?
In the context of evaluating United kingdom of great britain and northern ireland policy on estimating the social cost of carbon, Pearce (2003) argues that climate change is non 'special', in the sense that information technology should non be analysed inconsistently with other policy areas. Indeed, in its simplest course, environmental policy but requires internalizing (often negative) externalities and providing public goods, as do many other areas of state involvement. However, while the environment should non be given favourable (or unfavourable) handling, there are seven potential specific considerations apposite to the state's role in environmental protection.
Beginning, many environmental bug involve a degree of irreversibility, as a result of thresholds and non-linearities found in natural systems (Perrings and Pearce, 1994). For case, extinct species cannot (however) be brought into living existence, and the second police force of thermodynamics implies that some transitions are extremely costly or incommunicable to run backwards. While other forms of capital decisions also involve a degree of irreversibility, natural uppercase stocks may have peculiarly astute irreversibilities. The implications are that consequences of policy failure are likely to be more severe, so a precautionary approach is appropriate, which may require college environmental prices or more straight intervention from the land.
2nd, and related to the challenge of irreversibility, is the relevance of inter-generational considerations and sustainability. Sustainability issues arise in several other policy areas, but given that economic growth over the last century has led to extensive substitution away from natural upper-case letter towards manufactured capital ( Pearce et al., 1994), it is no surprise that the belittling appliance to address sustainability issues has been developed past environmental economists ( Pearce et al., 1989). In improver to addressing the sustainability challenge (by collating appropriate data and setting suitable long-term objectives), a further non-little challenge for the state is to conceptualize the preferences of humans in the distant future, which are highly uncertain from today's vantage indicate.
Third, we are often interested in the system-wide properties of the natural environment, recognizing that different species within an ecosystem, including humans, collaborate and depend upon other species. Some environmental protection may accept an analogy to the provision of macroeconomic stability, so that environmental policy must extend well beyond the simple microeconomics of internalizing externalities, to maintaining desirable organisation properties (such every bit low inflation, or a stable bee population to support man agriculture).
Fourth, relevant ecosystems often exercise not respect national borders, then policy must sometimes involve international coordination. The provision of international public appurtenances raises conceptual problems for the role of the state, because providing such goods involves multilateral coordination, and some weighting (explicit or implicit) on consequences abroad, relative to consequences at abode, is necessary. Furthermore, developing trust-based relationships with other nations is needed to overcome the inherent Prisoner's Dilemma problems. Some of the international dimensions of climate change are discussed further in section V.
Fifth, ecology policy sometimes involves more scope for rent-seeking than in other policy areas. For case, in climate-alter policy in Europe, property rights worth roughly €25 billion accept been allocated for costless to firms in a manner that is not entirely transparent or efficient, and so the pay-offs to lobbying have had the potential to be extremely high. Furthermore, the need for government to piece of work in partnership with the private sector to deliver environmental quality also increases interaction and the scope for rent-seeking. Finally, it might be argued that the coincidence of shared 'green values' between government civil servants and leading environmental firms enhances the likelihood of a greenish 'pork barrel'. That said, many other policy areas—agriculture is 1 instance—have enormous pork barrels, and so environmental issues are conspicuously non lonely in this respect.
Sixth, issues such as biodiversity preservation and climate change often rely upon more complex and uncertain science to underpin policy than in other areas, implying that policy-making by the state is more hard to become right. 13 The potential for unintended consequences of government policy is high. Yet, as Helm (1986) notes, in that location is no evidence for the presumption that such unintended consequences will be perverse, rather than benign or indeed beneficial. The implication here is merely that better analysis, and certainly greater humility, is required to deal with environmental challenges.
Seventh, some ecology problems are large enough to be non-marginal, so that the conventional shortcuts employed in cost–benefit assay are inappropriate (Dietz and Hepburn, 2010). However, this is true of many other areas, where big-scale investment in employment, wellness, transport, and defense, for instance, can have significant knock-on furnishings for the wider economy. Nevertheless, this means a system-wide, integrated approach rather than a marginal, microeconomic approach, is likely to be appropriate.
These various features hateful that intervention for certain environmental bug will crave a more cautious, long-term, nuanced, and sophisticated approach than in some other policy areas. Policy often cannot simply internalize environmental externalities and provide ecology public appurtenances, assuming that policy in other relevant areas is already 'offset best'. Broader macroeconomic issues and sustainability concerns created by conventional economical growth also need to be factored into ecology policy. However, this does not necessarily imply direct or heavy-handed government intervention. Rather, information technology suggests that good environmental policy requires the combination of a clear government vision most the top-level objectives and specific interventions that harness the analogous role of the price system where prices are, or tin be adjusted to be, reasonably shut to social costs.
III. Market place failure and environmental protection
(i) The provision of environmental protection by the free market place
Given the analysis above, it may seem extremely challenging to defend the simplistic view that the complimentary market can regulate itself to provide environmental protection superior to that provided with the assistance of authorities regulation. Nonetheless, recall that prior to the financial crises of 2008–ix, the view was expressed that financial regulation was similarly unnecessary, considering 'risks in fiscal markets are regulated by private parties' (Greenspan, 1994). Equally such, while it may seem obvious that government policy will be required, xiv in this section we consider only how far one might expect markets to provide environmental protection without regime intervention.
There are ii arguments for the view that firms will take at least some activeness to protect the environs without government regulation. Kickoff, if consumers are well-informed about ecology problems and are altruistically willing to internalize environmental costs, and then firms can address environmental bug past simply serving their customers and satisfying these preferences. Moreover, firms will make profits in and then doing. For instance, much to the surprise of many, a flourishing voluntary market in carbon offsets—where individuals voluntarily pay firms to reduce emissions and retire credits on their behalf—has developed and grown exponentially in contempo years, and was worth at to the lowest degree Us$400m in 2008 (Ecosystem Marketplace, 2009). xv Consumer-led environmental protection of this sort does not require 'corporate social responsibility' (CSR), divers as the sacrifice of profits for the social interest (Reinhardt and Stavins, 2010), as firms are only supplying the goods and services demanded past consumers.
Although there are pockets of altruistic consumers who are willing to internalize their own externalities, virtually consumers are not so generous. Voluntary markets for ecology protection are likely to remain marginal compared to regime initiatives without a major cultural shift, which seems unlikely to occur. Indeed, voluntary carbon markets have been chop-chop dwarfed by government-created emissions trading schemes with which firms are legally obliged to comply. While the voluntary market place was worth U.s.$400m, compliance carbon markets were estimated to be worth near 1,000 times more than, at around United states of america$120 billion in 2008 (Capoor and Ambrosi, 2009).
If consumers are largely unwilling to pay voluntarily, might shareholders be willing to accept lower profits? Reinhardt and Stavins (2010) consider the limits of CSR. They notation that the legal ground for the view that firms must exclusively maximize profits is surprisingly weak. If firms may legally cede profits in the public interest, and if other market imperfections provide them with rents that enable them to make such sacrifices on a sustainable footing, and then managers can devote some portion of shareholder returns to voluntary protection of the surroundings. However, despite a big literature on CSR, there is still no strong show that firms devote substantial profits to the public interest, and Reinhardt and Stavins conclude that such efforts will e'er remain complements to, rather than substitutes for, regime action.
In other words, every bit economists would expect, the evidence suggests that consumers are unwilling to pay (much), and shareholders unwilling to sacrifice profits (much), in order to protect the environment. In brusk, environmental issues will not be solved by 'free marketplace' or 'market-led' solutions. In dissimilarity, yet, agents who are unwilling to act individually may all the same be willing to act collectively (Sen, 1967). sixteen For this to occur, government tin provide coordination, backed by existent enforcement mechanisms. The more difficult questions, addressed in department 4, are when, where, and how regime intervention should occur.
(two) The potential of government-created markets
Although the unaided complimentary marketplace cannot be relied upon to accost ecology issues, a more persuasive view is that government can assist by creating and regulating environmental markets, which would otherwise exist missing. The classic case is, perhaps, emissions trading schemes, which provide firms with flexibility on how (and when) environmental objectives are met. Government sets the overall objectives, and leaves it to the market to deliver. Past establishing a cap-and-merchandise scheme (or setting an environmental tax) and leaving the remainder up to the private sector, the government can effectively consul the task of ecology protection to firms, without 'picking winners' and without detailed and planned intervention in specific ecology projects. Prices, rather than detailed planning, perform the coordinating function.
Over the past 2 decades, interest in environmental markets has increased, particularly with respect to acid rain and climate change, merely also in relation to biodiversity offsets and other ecosystem trading ( Nemes et al. 2008). Climate change appears reasonably well-suited to a market arroyo, as greenhouse gases mix globally (so the spatial location of emissions is irrelevant), and other approaches, such as carbon taxes, have historically encountered political difficulties (Hepburn, 2006). The canonical example of a greenhouse gas emissions market is the multi-billion euro marketplace created past the European Emissions Trading Scheme (EU ETS).
However, Hanemann (2010) casts uncertainty on the view that this relatively light touch volition be sufficient to accost a trouble such as climatic change. He argues that the acrid rain trading was only successful because of the presence of several preconditions—most critically the availability of set up technological solutions and low-sulphur coal—that enabled the achievement of short-run emission reductions through operational innovation and cost minimization. While a carbon price, delivered by a carbon market place, may well be a necessary component of successful climate-change policy, complementary government interventions are also likely to exist required.
A related conclusion is drawn by Newell (2010). Every bit is well known, at that place are (at to the lowest degree) two externalities in many environmental issues—the absence of a toll on emissions and the presence of positive spillovers from research and development (R&D). Getting environmental prices right is a necessary, just non a sufficient, status to evangelize optimal environmental R&D. Complementary policies, such as R&D back up, are required. Newell argues that government should assistance to compensate for underinvestment by private firms by focusing on areas firms otherwise ignore, such as fundamental research.
Furthermore, where environmental challenges require substantial capital expenditure and longer-term investment decisions, policy brownie is as important as getting the prices right ( Helm et al., 2003). Establishing a short-term market with appropriate prices is of little use if these price signals are not credible over the long-term investment horizon. A credible market place with prices that are moderately too low or as well high may exist superior to a market with 'perfect' short-term prices that firms exercise not believe will continue in the long term. For instance, the European union ETS faced particularly an acute credibility problem in its first phase, 2005–7, which has been partially addressed in the second phase, 2008–12. Credibility bug in UK and European union climate policy are also noted by Helm (2010).
The lesson is that while governments can intervene to make markets work amend, and to create otherwise missing ecology markets, the appropriate intervention varies with the nature of the environmental problem. For extremely simple environmental problems, information technology might be plenty just to get the prices right (or at least less wrong). For climate change, fifty-fifty getting carbon prices right would not exist enough—at that place are also many other market failures, the investment requirements are too long term, the investments are non-marginal, and international political economy considerations are critical. The carbon prices that have so far emerged from two decades of policy attention are nevertheless not apparent, and fifty-fifty if the spot prices were 'right' (which they are non), additional intervention would be required (Hanemann, 2010). These additional interventions might include support to advantage innovation, for case, or innovative financial mechanisms to increase the risk-adjusted return on investment to make large-calibration, long-term shifts in the economic system towards cleaner modes of product. But policies put in place to accomplish these ends demand to be mindful of the likelihood of government failure.
4. Authorities failure and environmental protection
(i) What authorities will non provide
Captain (1986) notes that '[j]ust every bit markets are rarely, if ever, perfect resource allocators, and so besides governments are rarely, if ever perfect planners'. There are two main reasons why governments are likely to be less than perfect.
Commencement, governments never have complete data. At that place is now a vast literature on the economics of 'imperfect economies', outlined past Stern (2009), starting time with Meade (1955) and proceeding past exploring optimal policy as imperfections are introduced into an otherwise perfect economy. Incomplete information is one such imperfection, and it is pervasive and disquisitional. In many areas of environmental policy, the information requirements of optimal policy are substantial. Determining the 'optimum' ofttimes requires accumulation complex scientific information on damages, determining consumer preferences such that those damages can exist valued in monetary terms, and so obtaining detailed information on aggregated individual-sector abatement costs so that a balance between costs and benefits can be struck. This much is required even nether a 'price'-based approach. Dietz and Fankhauser (2010) discuss the meaning levels of uncertainty involved in pricing climate-change damages, and explore pragmatic, only ultimately second-best ways to circumvent these uncertainties. For a 'planning'-based intervention, optimality further requires that the government know each and every house'due south individual abatement cost function. Fifty-fifty in a communist state, this information is enormously costly, if non simply impossible, to obtain. In most autonomous societies, even if it were possible to acquire reliable data on the abatement costs of millions of individuals and firms, they do non have to disclose this information to government, and, indeed, may not wish to practice and so.
2d, governments are comprised of individual humans, and humans are subject to lobbying, manipulation, and subtler forms of persuasion by others who have an incentive to shape policy for their ain benefit. 17 As Anthoff and Hahn (2010) and Helm (2010) demonstrate, political economy considerations, including 'regulatory capture', often foreclose authorities interventions from generating anything resembling 'optimal policy'. In Europe, the policy process that resulted in the Eu ETS involved a serial of concessions to manufacture that reduced both the efficiency and effectiveness of the scheme.
Unfortunately, awareness of rent-seeking problems does not announced to aid governments to overcome them. Policy-makers in the United states of america have had the benefit of observing the emissions trading scheme existence negotiated in Europe, and yet experience with the various U.s.a. legislative drafts on energy and climate change of 2009 and 2022 suggests that the consequence, if, indeed, there is 1, will exist just as inefficient, with large pay-offs existence fabricated to powerful incumbents.
Regime failure is not only limited to the design of emissions trading schemes. It is unlikely other policy instruments, such as environmental taxes, would fare much meliorate. The betoken is that when 'government failure' is likely, the political economist should avoid comparing 'optimal' trading schemes with 'optimal' taxes, and instead examine 'realistic' trading schemes (given the relevant set of interest groups and their incentives) and 'realistic' taxes. For instance, one might compare short-term trading schemes where near of the permits are handed out for free, with taxes that are also depression, with many exemptions, and which are tinkered with over time.
(2) What are realistic expectations of regime?
Despite this somewhat pessimistic business relationship of the potential for government to intervene without failing, at that place are several things that merely the country can do, and which it is reasonable to expect that information technology should do. First, it is reasonable to expect that regime be able and willing to prepare out a clear, overarching vision and top-level objectives. Marketplace participants are not in a position to prepare overall objectives for the economy, because they are compromised by their ain interests and because they lack the coercive power to pattern interventions that incentivize economic behaviour towards those objectives.
The expectation that authorities will ascertain tiptop-level objectives implies that authorities needs to compile national accounts that describe, at least roughly, the existent income and wealth of the economic system. For the large role, however, governments neglect to meet this expectation because of the continued inaccurate accounting treatment of natural capital and other non-market place appurtenances and services ( Stiglitz et al., 2009). While some efforts are being made to measure appropriate indicators, such as the growth charge per unit of per capita 18-carat wealth ( Arrow et al., 2004), it will be difficult to ascertain and implement top-level objectives until appropriate national indicators are available. Sustainable economic growth is an important policy objective for many nation-states, still electric current economical growth pathways appear to exist converting natural capital into manufactured capital at a rate that is unsustainable. Identifying critical natural capital stocks ( Pearce et al., 1996) and their relevant thresholds is arguably an important role for government.
Second, information technology is reasonable to await that government will, in an iterative and sometimes erroneous way, gradually move towards the adoption of policies that move the economy towards, if non achieve, the overall ready of acme-level objectives (howsoever defined). Getting the prices 'right' seems oft to be besides much to expect; getting them 'less wrong' should be achievable.
3rd, the state tin can reasonably be expected to ensure that the 'rules of the game' specified by its policies are implemented in an impartial and off-white manner. While whatsoever major shift in the rules themselves (such as the introduction of carbon pricing) will inevitably create winners and losers, the implementation of the rules should be clear and predictable so that firms can trust the price signals emanating from government.
Quaternary, ideally the rules would be relatively stable, and not changed retroactively. Unfortunately, evidence suggests that this is ofttimes too much to ask. Conditions are continuously changing, and the temptation to opposite previous decisions, and to exercise so in a retroactive way, is ofttimes irresistible.
5th, policy should be designed with an explicit assessment of whether it allocates risks to the parties in a best position to bear them. Sensible adventure allocation will reduce the overall social costs of the intervention.
What does this imply for environmental policy? If authorities tin can deliver on these reasonable expectations, then there is likely to be a large domain in which government intervention for environmental protection is likely to be preferable to market failure.
With these considerations in mind, if government is embarking on a large-scale stimulus to escape recession, funds might be deployed for spending on long-term infrastructure investment (rather than consumption) to support natural capital stocks and reduce their depletion rates (Bowen and Stern, 2010). Unfortunately, the recent opportunity for such investment was largely missed, with merely roughly 15 per cent of fiscal stimuli estimated to accept been directed at 'green measures' (Edenhofer and Stern, 2009; Robins et al., 2009). 18
At present, with budget cuts looming, government policy on the surroundings might instead focus on reforming the tax system away from taxing goods and towards taxing bads, including environmental pollution. This would deliver shifts in relative prices (in a potentially revenue-neutral fashion); or might enhance revenue from ecology taxes and/or the auctioning of environmental allowances and/or the reduction of fossil subsidies.
Only changing relative prices in a acquirement-neutral fashion will not ever be sufficient, for three reasons. First, in add-on to the relevant ecology externality, the R&D externality is often difficult to internalize without some form of public subsidy (Newell, 2010). 2nd, attempts to price the relevant externalities rarely deliver first-best results, considering optimal prices are either impossible to determine (Dietz and Fankhauser, 2010) or politically impossible to implement. Every bit such, complementary measures are often required (Hanemann, 2010). Third, the scale of the climate-change claiming is such that extraordinary levels of investment are required to shift the economy on to an environmentally sustainable pathway. For instance, while the numbers are inevitably highly uncertain, the International Free energy Bureau (2009) estimates that the globe might require additional cumulative investment of U.s. $10 trillion in the flow 2010–30 in guild to follow a 450ppm pathway consistent with increasing energy demand. Further sums are required to protect the remainder of the globe'due south tropical forests, and the carbon stocks and biodiversity therein. The Copenhagen Accord on climate change of December 2009 anticipates transfers from rich to poor of US$100 billion annually by 2022 (UN FCCC, 2009). In the Uk alone, Helm (2009) roughly estimates that effectually £50 billion per annum is needed for general infrastructure investment over the adjacent decade to 2020, of which over xx billion is direct or indirectly related to the transition to a low-carbon economy.
In do, encouraging investment on this calibration is likely to require more than only the adjustment of relative prices; additional funds will be necessary. If public funds are not available, individual capital might exist incentivized to fill the gap. Hither, the principles outlined higher up are particularly of import: (i) national accounts should exist reasonably authentic so that objectives tin can be accordingly determined at the outset; (ii) environmental prices should be roughly correct; (3) rules should exist established and implemented in a fair and impartial fashion; (four) rules should be stable and not changed retroactively; and (five) hazard should be efficiently allocated. With these principles in place, it is possible to provide an appropriate risk-adjusted return to induce unsentimental private uppercase to menstruum to the necessary environmental investments.
V. The international dimension of environmental policy
(i) Context
Ecology issues often practice not neatly map on to national boundaries. Many pregnant problems are transboundary (due east.thousand. water pollution in major rivers, acid rain) or international (e.g. climate change, over-fishing, biodiversity loss). For international problems, the human relationship between government and the market is complicated past the fact that there are many governments and many markets. Determining appropriate roles for 'planning' and 'prices' in a complex political and international context is challenging. However this is what is required, because the interactions between states and firms ultimately determine whether environmental problems are solved, and at what cost.
In the case of climate change, fiscal support for developing countries to reduce greenhouse-gas emissions was one of the cardinal bug in discussions leading up to the United nations FCCC conference in Copenhagen in December 2009. As noted to a higher place, the International Energy Bureau (2009) estimates that additional free energy-related investment of US$10 trillion will be required to 2030, of which United states$200 billion per annum would be inside non-OECD countries past 2020. Yet developing country governments have other pressing demands for their capital letter, and they see climate change as historically caused by rich western countries who are likewise in the best position (financially and technologically) to mitigate the consequences. Yet western governments are also apparently unwilling to classify the necessary upfront majuscule.
It follows that the low-carbon investment requirements will not be met without the appointment of private capital letter. Institutional investors, such as pension funds, could provide much of the capital if an appropriate run a risk-reward rest were available. It is estimated that pension funds alone control assets worth more $12 trillion and that sovereign wealth funds take a further $3.75 trillion under direction (Vivid Economics, 2009). Notwithstanding, to redirect those funds from loftier- to low-carbon activities, the expected returns on climate-change mitigation need to be commensurate with the perceived level of take a chance. Investment risks in developing countries include political risks (of state of war or expropriation), currency risks, project management risks, too as uncertain international and national government climate-change policies.
Institutional investors have consistently chosen for the implementation of apparent long-term climate-change policies, so that they tin justify redirecting capital towards solving the problem. This is also likely to exist in the interests of the taxpayer, because credible long-term policy reduces the cost of uppercase and hence the overall cost of delivering low-carbon infrastructure investment in the energy and transport sectors. While rich countries accept significant brownie problems ( Helm et al., 2003), the climate policy brownie problems in poorer countries are arguably even more than acute.
For these reasons, the treasuries of rich countries take been asked to consider the potential for supporting low-carbon investment in developing economies using culling finance mechanisms such as take a chance guarantees, concessional loans, and softer forms of political and policy insurance ( Neuhoff et al., 2009; London School of Economic science, 2009; Vivid Economics, 2009). These mechanisms, which leverage public residuum sheets without involving the direct provision of upper-case letter, are referred to in this context as 'public finance mechanisms' (PFMs).
(ii) Public finance mechanisms
The first-best approach to stimulate the investment of the requisite amounts of institutional capital is clearly to enact domestic regulations that provide credible long-term carbon price signals to investors. In the international context, so-called 'advance marketplace commitments' proposed by Barder et al. (2006) appear to warrant further investigation.
As a complement to (partially inadequate) domestic climate policy, carefully designed PFMs may be able to leverage considerable amounts of private investment, potentially upwardly to $3–15 for every $i of public funds (Bright Economics, 2009), by reducing risk such that the risk-adjusted return of the project clears the relevant hurdle charge per unit. PFMs have tended to be implemented on a project-by-projection or programmatic basis, and correspond state intervention closer to the 'planning' rather than the 'prices' end of the spectrum, described in section Ii(ii) above. As with many such government interventions, there have been both positive and negative previous experiences to appointment.
Ane instructive positive feel is the coordination of the complex Baku–Tbilisi–Ceyhan (BTC) pipeline to export oil from Republic of azerbaijan, which opened in 2005. Complex infrastructure projects of this nature are likely to exist necessary to reduce emissions from the energy sector globally. The BTC project involved 11 oil companies (led past BP, the project sponsors), 15 commercial banks, two public international financial institutions (IFC and EBRD), eight export credit agencies (ECAs), and diverse regime authorities. The total investment was $3.8 billion. Without the involvement of the two public international financial institutions, it is considered less likely that the project would have proceeded (Vivid Economics, 2009), because they provided cover for political and ecology risks, enhancing the enforceability of host regime agreements and helping to ensure a transit deal for Georgia, reducing the take a chance of future disputes and interruptions. It is estimated that $10 of private debt was raised for every $i of public debt provided from the IFC and the EBRD.
There are at least four useful lessons from by experience with PFMs if they are going to incentivize institutional investors to classify their capital letter to depression-carbon infrastructure in developing economies ( Neuhoff et al., 2009; Vivid Economic science, 2009). Get-go, at that place are multiple market failures, layered on tiptop of the greenhouse gas externality, that complicate the international dimension of the response to climatic change. These include financial market failures, such equally the absence of a market place for long-term currency risk exposure, or for political risk coverage in several countries. As such, multiple government interventions are likely to be required.
Second, the institutional architecture for delivering these instruments matters. The more political the institutions, the greater the run a risk that the credibility trouble has not been eliminated, but has rather simply been shifted from one establishment to another. Experience suggests that the multilateral banks may be better channels of public finance than national governments in this context.
Third, the value of coordination appears to be very loftier. Bringing the relevant state and individual parties together to build agreement and trust, to analyze incentives and to negotiate contractual structures that are consequent with self-interest may make the divergence between success and failure. In any such collaborative forum, even though the public bodies are not regulators, the risk of regulatory capture rises considerably. Militating confronting that is the requirement placed on international financial institutions to make market or near-market returns on their investments.
4th, institutional investors seek investments at a very large scale, commensurate with the quantities of capital on their balance sheets. It follows that if PFMs are to shift the direction of institutional investors towards protecting natural capital, they must influence investment opportunities at scale, which implies tipping the profitability of major projects for large corporations, or shifting profitability of a large number of smaller projects which tin can exist aggregated into a fund by a manager and pitched to institutional investors to attract their capital.
These lessons indicate that finding appropriate models of public–individual cooperation for large-scale, low-carbon infrastructure projects will be difficult, only not impossible. Risks of inefficiencies and capture are present, and structuring the incentives is challenging, just every bit public treasuries are unwilling and probably unable to nationalize the delivery of low-carbon infrastructure, and as 'prices' alone are bereft, relatively complex arrangements between firms and governments may exist necessary.
6. Determination
The blueprint of ecology policy, as with other policy areas, requires an understanding of the advisable border between the state and the market place, and a apprehensive appreciation of the fact that both governments and free markets fail a great deal of the fourth dimension. Understanding these limitations and designing interventions accordingly is likely to be an of import determinant of whether critical environmental challenges are successfully addressed in the coming decades.
The analysis in this newspaper suggests that approaches to environmental protection at either extreme of the spectrum—'free marketplace' and 'nationalized delivery' of environmental protection—are unlikely to deliver optimal results. The appropriate model of environmental intervention will most often lie in the middle. While general rules to specify the precise form of intervention are not available, several of import principles for policy design were gear up out in this newspaper and the others in this issue of the Oxford Review of Economic Policy.
Get-go, data matters. If the decentralized market has an advantage over the centralized state, policy should simply focus on 'getting the prices right' (or at least less wrong). Second, setting acme-level objectives also matters. Some policy bug cannot be left to market participants because they are cocky-interested and are unable to decide a social optimum, or because the degree of coordination and planning required is too great. 3rd, master–amanuensis issues affair. Bureaucrats do not necessarily maximize social welfare and may be captured by individual interests; nor practice chief executives necessarily maximize long-term shareholder value. Agreement these problems is important for environmental policy design. Fourth, organizational structure and competence matter. Talent and incompetence are to be constitute in both public and individual sectors; an incompetent private sector may be worse than a competent public sector, and vice versa.
While environmental problems share the features of other public-goods problems, they too often have characteristics that merit more careful consideration, such as irreversibility, intergenerational and sustainability issues, systemic effects, international dimensions, significant scope for rent-seeking, loftier levels of uncertainty, and non-marginality. These features imply that environmental policy may often exist more challenging than other policy areas, requiring government to provide clarity about the top-level objectives, coupled with credible policy interventions that explicitly or implicitly internalize social costs and harness the price system to provide investors in natural majuscule with an advisable risk-adjusted return. That said, we take also seen that for environmental problems such equally climatic change, prices interventions may be necessary but non sufficient. Complementary measures are likely to be required to address other market failures and to overcome patterns of environmentally detrimental behaviour (Hanemann, 2010). Finally, given the forecasts of enormous investments required to accost climate change, one important role of the state is to provide a articulate policy framework with apparent, stable rules to produce an appropriate adventure-adjusted return that induces private capital to invest in relevant natural capital and environmental technologies to protect it.
I gratefully admit helpful comments from Anna Skarbek and Ian Temperton, and extremely insightful suggestions from Dieter Helm, although I take responsibility for remaining errors and omissions.
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two As a thought-experiment, assume that a complimentary, carbon-neutral source of energy is discovered tomorrow, such that climatic change is solved at no cost. The marginal productivity of the other (non-energy) factors of production would increment and economical growth would accelerate, leading to even greater pressure on natural capital, such as renewable resources and biodiversity.
iii Biodiversity is important because, in improver to its intrinsic value, option values, and pharmaceutical values, it appears that so-called 'functional biodiversity' may play an important function in regulating ecosystems and shoring up ecosystem resilience ( Folke et al., 1996, 2004).
iv An alternative measure out of the extent of state interest in the economy might be the quantity of regulation, simply rough aggregate measures of the quantity of regulation are likely to exist unhelpful (Captain, 2006).
five Helm (1986) and the papers nerveless in vol. two no. 2 of the Oxford Review of Economic Policy provide excellent analyses of issues relating to the economical borders of the state.
half-dozen Key examples of environmental legislation in the US from that menstruation include the Air Pollution Command Human activity in 1955, the Wilderness Act in 1964, the National Environmental Policy Act in 1969, which created the US Environmental Protection Agency, and the Clean Air Act in 1970.
vii Pigou (1920) proposed pricing emissions directly through pollution taxes, and, following Coase (1960), information technology was realized that the allocation and trading of property rights, such equally marketable emission permits, would accept similar efficiency backdrop (Crocker, 1966; Dales, 1968; Montgomery, 1972).
9 Pigou (1929) argued that these fluctuations stem from footling more than 'variations in the tone of mind of persons whose action controls industry, emerging in errors of undue optimism or undue pessimism'. Arguably less mystical and more mundane explanations of the presence of large-scale socially unproductive incentives were more relevant to the 2008 fiscal crisis.
xi Asheim (2010) provides a conscientious formal account of the various reasons to be cautious in the darkening or manipulation of information in an attempt to shift preferences and behaviour.
12 The view that market economic systems function in a mode analogous to ecological systems, subject to the forces of natural choice, is noted by Keynes (1926) and developed by Helm (1984).
xiii This applies only every bit strongly to the technological developments that may reduce ecology problems. For example, recent breakthroughs in the exploitation of anarchistic shale gas, which announced to increment reserves in the United States from effectually 10 to 90 years (Ruester, 2010), may also significantly reduce the marginal cost of greenhouse gas abatement in the medium term (Hoyas and Crooks, 2010).
fifteen This figure excludes an additional US$300m in volumes on the Chicago Climate Exchange (CCX), which while strictly 'voluntary' may be partially motivated by firms seeking early on credit for 'pre-compliance'. Alternatively, firms may merchandise on the CCX to learn about carbon markets and to refine their strategies earlier the imposition of a mandatory authorities.
16 The view that 'citizen preferences' may be different to 'consumer preferences' is likewise relevant in this context (Sagoff, 1988).
18 Ii notable exceptions are People's republic of china and South korea, which devoted effectually 30 and 80 per cent, respectively, to 'light-green' measures (Edenhofer and Stern, 2009).
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